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2012/SOM2/EC/019 Agenda Item: 6

Lease Accounting Proposals and the Role for APEC

Purpose: Information Submitted by: ABAC United States

Second Economic Committee MeetingKazan, Russia

30-31 May 2012

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Lease Accounting Proposals Lease Accounting Proposals and the Role for APECand the Role for APEC

IFRS RoundtableIFRS RoundtableEconomic CommitteeEconomic CommitteeSecond APEC Senior Officials MeetingSecond APEC Senior Officials MeetingK R iK R iKazan, RussiaKazan, Russia

Tom ClarkTom ClarkMay 30, 2012

Overview

• Background: Why a lease accounting project was

undertaken

• Lessee accounting and Lessor accounting proposals

• Impact of proposals; tie-in to APEC agenda

• Private sector comments on the lease proposals

• Suggestions for APEC role and Recommendations

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Background

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Why the project was startedThe staff recommends that the accounting guidance for leases be reconsidered. The current accounting for leases takes an "all or nothing" approach . . . .J 15 2005June 15, 2005SEC Staff Report on Off-Balance Sheet Arrangements, Special Purpose Entities and Related Issues

One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet…that is on an airline s balance sheet…25 April 2008Sir David Tweedie, IASB Chairman, Speech at Empire Club of Canada (Toronto)

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Leasing: perception vs. realityWhat people think of when leases are mentioned . . .

What the statistics actually show . . .

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Project Timeline

ED IssuedAugust

Decision on Re Exposure

July 2011

Redeliberations Jan 2011 -

Comment Letters

Dec 2011

Revised ED Final

Comment Letters

T+120 Days1st or 2nd

Final Discussions Mar/Apr

Redeliberations

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Project timeline• Leases Exposure Draft (ED) Issued August, 2010

• Significant Response: Over 780 comment letters to ED

• Commentators generally identified similar issues

• Comments have significantly affected the direction of the lease project

g2010

July 2011s Jan 2011Ongoing

Dec 2011 late 2012?

Outreach

Final StandardLate 2013

Q2013

Outreach

s Mar/Apr 2012?

s Begin 2nd or 3rd

Q2013 Outreach

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lease project

• Depends on progress and changes to ED

• February meetings threw project into a turmoil

• Effective date uncertain, may be tied to revenue recognition project – likely not sooner than 2016

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Lessee Accounting (Right of Use)

AndLessor Accounting

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Lessor AccountingModels

Overview of right-of-use model• Lessee will recognize

– An asset representing the lessee’s right to use the leased asset– A liability for its obligation to make lease payments

A if h d if d bt d l– An as if purchased, as if debt model

• Assets and liabilities initially recognized and measured as of lease commencement date

• Liability is the present value of lease payments– Discounted using rate the lessor charges the lessee (when available),

or– The lessee’s incremental borrowing rate

Ri ht f t i d i iti ll t t

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• Right-of-use asset is measured initially at cost– Amount of the liability– Plus: any initial direct costs incurred– Less: any lease incentives received

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Lessee cost allocation

Potential Impact of Lessor Operating Lease Accounting on Lessees. Many of the Board members indicated that they believed it was important to emphasize that their tentative decision on lessor accounting for investment property leases was not

The issue that will not go away. . . .

g p p ymade for conceptual reasons so that lessees would not be able to assert a basis for applying operating lease accounting to some of their leases. However, a majority of the FASB members expressed a preference to reconsider lessee accounting for leases of investment property, while a majority of the IASB members expressed a preference not to reconsider lessee accounting for leases of these assets. The FASB did not indicate when it would undertake this reconsideration.

KPMG Defining Issues® October 2011, No. 11-54

Lease Rule Would Hit Profits By EMILY CHASANBy EMILY CHASANWall Street Journal, November 16, 2011Retailers, banks and airlines, which often use long-term leases to add to their locations or aircraft fleets, are pushing back against a proposed accounting rule that would act as a drag on their profits. . . . . Most American companies are resigned to the centerpiece of the overhaul: treating leases—or the right to use a piece of property or equipment—as a new kind of asset.

$25,000

Lessee Expense Pattern Comparison

$10,000

$15,000

$20,000

Lease Payments

Straight-Line Rent Expense (Current U.S. GAAP)

Interest and Amortization Expense

Amortization Expense

Interest Expense

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$0

$5,000

Lease Term

Interest Expense

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Lessor Accounting Proposals

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Receivable and residual approach will be the core model

Lessor accountingOverview

• Receivable and residual approach will be the core model

• Similar to the derecognition approach in the first ED

• Boards are attempting to align lessor accounting with the revenue recognition project

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• Recognize a receivable• Remove a portion of the asset

All t th i t f th d l i t b t i ht f

Lessor accountingApplying the receivable and residual approach

− Allocate the carrying amount of the underlying asset between right of use granted (cost derecognized) and residual asset on a relative fair value basis

− Derecognition formula: asset value – [(value of payments/FV of asset) X asset value]

• Profit recognized for the difference between the lease receivable recognized and the cost derecognized− Profit relates to the right of use granted to the lessee

A h i i ifi t h f

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• Approach is a significant change for− Operating leases− Sales-type leases

• No change for direct finance leases

Significant CommonSignificant Common Elements

of Lease Accounting

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Questions addressed by the Boards

How does

What is the interest factor?

What is a lease?

What is the lease term?

What are the lease

payments?

How to account for short term

a lessee allocate cost?

How does a lessor

recognize income?

When to reassess?

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short term leases?

se Imputed Interest Expense + Depreciation

Front End Loading of Lease Expenses16

Boo

k E

xpen

Str LineRent Exp

Depreciation of ROU Asset

Imputed Int Exp

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Lease Term

Mid PointExpiry

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Who is Affected? Illustrative U.S. Examples

Walgreen’s

Target

CVS

Wal-Mart

JP Morgan

FEDEX

Home DepotBank of America

Citigroup

FEDEX

Delta Airlines

US Air

Source: Bill Bosco, Leasing 101

Issue Impact

New ROU asset & lease liability capitalized

Same as S&P and Fitch, less than Moody’s capitalizes - impacts ratios & measures

Debt covenants May cause debt limits to be hit – need to review and

Lessee Issues & Impacts & Impact18

ebt co e a ts ay cause debt ts to be t eed to e e a dre-negotiate – is the liability “debt”?

Lease costs front ended Up to 28% > than Current GAAP in year of transition, turn around at mid point in term – ROU leases should have SL lease costs – they are executory contracts

Cash rent pd = IRS tax deduction New deferred tax assets on B/S

Bundled payment Must break out service to avoid capitalization

Lease cost more evident Capitalize interim rents, CFO involved

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Lease treated as capital item No longer in operating budget, tougher internal approval process

Simple short-term lease method Good news for terms 12 mos or < & certain renewals

Compliance costs Transition, ongoing process, complex

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If lease terms are shortened

Lessor:• Increased asset/residual risk• Lower leverage/pricing changes

Possible business impacts

are shortened

If renewal options

Lessee:• Increased renewal risk/reward• Operational disruption• Higher pricing

Lessor:• More upside• Greater remarketing emphasis

If renewal options fall out of favor Lessee:

• Less flexibility• Increased exposure to market

change

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Risks less financing capacity; higher borrowing cost, liquidity

Lease Accounting and APEC

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ABAC PerspectivesDespite there being overall support for implementation of IFRS, many private sector organizations have their concerns. As pointed out last year, ABAC has concerns on some of the newly proposed accounting standards . . . the proposed changes on lease accounting (IAS 17) may have potential business and economic impact, such as on the availability of financing for SMEs During the implementation of IFRS it is important to

November, 2011ABAC Report to Leaders

The IASB/FASB preliminary analysis of submissions noted that significant concerns were raised with the ED, including, as most concerns ABAC, the potential for the rules to have a

l f l b l f S h C

availability of financing for SMEs. During the implementation of IFRS, it is important to examine the economic and business impact of the accounting standards . . .

negative impact on lease financing availability for SMEs. Among the concerns ABAC shared, was the reduction in the ability of businesses, particularly SMEs to access funding in many APEC economies and the funding ability of both lessees and lessors would be constrained as lease financing, currently a significant component of overall liquidity available to businesses, would become scarcer.

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Recommendations• Establish a task force to study smooth introduction of IFRS

to ensure appropriate communication among IASB, FASB, APEC and ABAC.

• Undertake an impact study on certain provisions, such as those related to lease financing and insurance contracts noted above, and make suitable adjustments, to avoid negative business and economic impact.

• Continue to encourage a dialogue between business groups and IASB/FASB on ways that would align IFRS principles with the interests of SMEs and other businessprinciples with the interests of SMEs and other business groups, such as insurance companies, that will be affected.

• Adoption by economies of IFRS should take into account ways of satisfactorily dealing with the concerns raised by business groups.