Impact Series

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Revised ED on Leases – lessee accounting

What you need to know

• Joint exposure draft (“ED”) between the International Accounting Standards Board (IASB) and the US based Financial Accounting Standards Board (FASB);

• Boards wants to change existing lease accounting to improve transparency, improve quality and comparability and remove incentives to create structures for off balance sheet accounting

• Replaces the first ED on leases issued on 17 August 2010 for which more than 760 comment letters were received;

• New ED considers the feedback received from those comment letters and from more than 300 outreach events throughout the world. It is expected that standard will not be significantly different than this ED.

For all leases of more than 12 months, an entity will need to recognize assets and liabilities for the rights and obligations

BALANCE SHEET MODEL OR “RIGHT OF USE MODEL”

Does this impact all my leases and renting contracts?

Probably yes, only limited exceptions such as lease of intangible assets; leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources; leases of biological assets and service concession arrangements (IFRIC 12)

Specified identified asset = explicitly or not explicitly specified in contract unless the supplier has substantive rights to replace the assets throughout the term of the contract

Right to control the use = direct the use of and derive benefits from the identified asset

A contract contain a lease if :

Fulfilment of the contract depends on the use of an specified identified asset;

The contract conveys the right to control the use of the identified asset for a period a time in exchange for a consideration.

Lessee accounting model – Identification? 1/3

Based on idea that a lease reflects a “right of use” a certain assets or group of assets granted by the lessor towards the lessee at the start of the lease

The “right-of-use” model requires that

• for leases with maturity of more than 12 months (including any renewal options), the lessee should recognize an asset to reflect its right to use the asset and a liability to reflect the future lease payments.

• For leases with maturity of 12 months or less (including any renewal options), the lessee has the option to recognize assets and liabilities but can opt to keep those leases off balance (accounting policy choice by class)

Operational car and truck leases and renting Aircraft leases Computer and office hardware Industrial equipment leases Commercial real estate leases / renting / land

Lessee accounting model – Identification? 2/3

You need to classify the lease in type A or type B, depending on whether a significant portion of the economic benefits embedded in the underlying assets are consumed or not by the lessee

In general, 2 type of leases (“dual approach”):

Type A – lease term is for significant part of the total economic life OR present value of the lease payments is significant to the fair value of the underlying assets (most leases other than property) OR if lessee has a significant economic incentive to exercise an option to purchase the asset

Type B – not TYPE A leases (mostly property leases)

For leases that contain both land & building, consider only economic life of the building to determine lease type

2 type of leases depending on consumption of the assets TYPE A – most leases other than property TYPE B – mostly property

Lessee accounting model – Identification? 3/3

Lessee should separate each lease component within the contract and recognize & measure separately but with 2 conditions : • only if lessee can benefit from the assets on its own and • underlying asset is not dependent on or highly interrelated with the other

underlying assets in the contract Allocate consideration to each lease component based on

1. its stand-alone observable prices; 2. Remaining consideration to components with no stand-alone observable

prices and recognize as ONE lease component; 3. If no stand-alone observable prices for any component, no separation

required

Separation of several lease components in one contract Allocate consideration to lease components based on observable prices or residual value

How do I measure the asset and liability at inception? 1/2

What is included in the lease payments? • Fixed lease payments • Variable lease payments that depend on an index or a

rate (e.g. consumer price index) or that are in substance fixed payments

• Amounts payable under the residual value guarantees • Exercise price of purchase option if the lessee has a

significant economic incentive to exercise the option What is the lease term? • Lease term is non-cancellable period together with

i. periods that are covered by an renewal option if the lessee has a significant economic incentive to exercise that option AND

ii. by a option to terminate the lease if the lessee has a significant economic incentive NOT to exercise this option.

How do I measure the asset and liability at inception? 2/2

• Measurement initial lease liability = present value based of the lease payments over the lease period

• Use rate the lessor charges the lessee as discount rate OR if not known, the entities incremental borrowing rate

• Cost of the right-of-use assets is i. Initial measurement of the lease liability ii. Any lease payments made to the lessor at or before the commencement of

the lease, and any lease incentives iii. Any direct initial costs incurred by the lessee

Right of use asset and lease liability are initially measured at the present value of the lease payments both for type A and type B with rate the lessor charges the lessee or if not known the incremental borrowing rate

How do I subsequently measure the asset and liability?

TYPE A lease TYPE B lease

Right-to-use asset Amortize over useful life or lease term if shorter based on straight-line method or expected consumption

Amortization is difference between periodic lease cost and periodic unwinding of the discount on lease liability

Lease liability at amortized cost basis at each reporting date with constant period discount rate

Expense recognize unwinding of the discount as interest separately from the amortization of the right-of-use asset

Recognize a single lease cost, combining the unwinding of the discount with the amortization of the right-of-use asset

What about the disclosure requirements?

• Right of use assets and lease liabilities TYPE A and TYPE B need to be disclosed separately either in statement of financial position or in the notes

• In statement of comprehensive income, present • Type A – unwinding discount separately from the amortization • Type B – unwinding discount together with the amortization

• In statement of cash flows: • Repayments principles portion TYPE A as financing activities • Unwinding discount TYPE A as interest paid • Payments TYPE B leases as operating activities • Variable lease payments and Short-term lease payments within operating

activities

• Additional disclosures requirements

Other important points that you need to know?

Remeasurement required of the lease liability (not the asset) if

i. There is a change in relevant factors that would result in a change in the lease term ; residual value guarantees OR

ii. There is a change in the index or a rate used to determine the lease payments

Significant modification to the lease contract = account for the modified contract as a new contract with difference with existing lease to profit & loss

Only FASB has granted nonpublic entities reliefs for the following :

i. Use of a risk-free discount rate to measure the lease liability (accounting policy choice)

ii. Exempt to provide reconciliation between opening and closing lease liability

IAS 36 impairment is applicable

Transition: retrospectively to leases that exist at beginning of earliest comparative period OR full retrospective in accordance with IAS 8

Expected effective date : unknown but not earlier than annual reporting periods starting in 2015

What does this mean for my business and organization?

Most likely, most organizations will be significantly impacted:

As most leases will be on-balance, decisions about financing capital investments may be significantly impacted;

Existing covenants under financing arrangements may be negatively impacted and may need to be renegotiated (e.g. covenants based on net financial debt, capital expenditures restrictions, interest cover ratio’s, etc.)

Organization will need to change processes in order to identify and document all lease components / lease contracts

Organization will require a tool to document / measure / report on all lease contract at group level

Investor may start looking differently to the performance and financial position of an organization

The new lease standard may have quite some implications on investment financing decisions, covenants, processes, tools, reporting, financial ratio’s

Contact

For more information about lease accounting or any other IFRS

matter, contact Sam Verfaillie, partner at Finvision Alliance at

sam.verfaillie@coneybelgium.be or +32 478 98 28 64

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Finvision bv bvba Kempische Kaai 29/02 3500 Hasselt T: +32 (0) 11 24 91 70 info@finvision.be www.finvision.be

@Finance BVBA Evolis 102 8530 Harelbeke (Kortrijk) T: +32 (0) 56 20 66 70 info@atfinance.be www.atfinance.be

Coney BVBA Zuiderlaan 14 bus 12 1731 Zellik(Brussels) T: +32 (0) 2 808 20 40 info@coneybelgium.be www.coneybelgium.be

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