PwC’s Leasing Discussion

PwC

Overview of the Leasing standard

2

PwC

Lease Accounting Scope & Impacts

3

Wh

at’

s i

n? • All industries, all

entities

• Arrangements that meet the definition of a lease

• Embedded leases within other arrangements

Wh

at’

s o

ut?

Leases of:

• Inventory or construction in progress

• Intangible assets

• Biological assets

• Exploration rights

• Natural resources

• Software

• Incl. internal use

• See ASU 2015-05

Scope

2019201820172016

Comparative reporting periods

Final standard

Effective date

Current standardFinancialreporting:

New standard

Dual reporting (US GAAP)

Note: Additional Year for non-public companies

Timing

Balance sheet

• Virtually all leases coming on balance sheet

• Asset & obligation (similar to today’s capital leases)

P&L

• Dual recognition model for US GAAP

• Interest & amortization vs. single lease expense

Disclosures

• Enhanced qualitative & quantitative disclosures required

Transition

• Modified retrospective approach required

• Specified reliefs available (some must be elected as a package)

PwC

Recognition

4

Lessee

Finance

Operating

Sales/Direct Financing

Operating

Lessor Balance sheet Income statement Cash flow statement

Right-of-use asset

Lease liability

Front loaded • Amortization expense• Interest expense

Lease expense

Interest = OperatingVariable = OperatingPrincipal = Financing

Operating

Balance sheet Income statement Cash flow statement

• Lease receivable • Unguaranteed

residual • Deferred

profit (DFL)

• Underlying asset remains

Front loaded• Interest income on

receivable and residual

• Profit (immediate or deferred)

Lease income

Operating

Operating

PwC

Summary of a lessee’s financial statement impact

5

ASC 840 ASC 842

Definition of a lease Control or output Control

Lease classification Bright linesBright lines

removed

Balance Sheet

Operating leases are off-balance sheet for

lessees

Lessee’s record virtually all leases

Income statement Dual model

Inception versus commencementMeasurement at

inceptionMeasurement at commencement

Reassessment On modification Event based

Lease versus non-lease components Similar in concept but some changes

Statement of cash flows Similar to today

Transition N/AOne model with

specific expedients

PwC

Illustration—Finance vs. Operating

6

Assumptions:

Lease Term 5 years

Annual rents (arrears) 100,000$ Assume no executory costs, variable pmts, or IDCs

Annual rent escalation % 2%

Lessee IBR 5%

Beg Liability & RoU Asset 449,746$ PV of rents

Calculations:

Year Cash rentals Interest

Ending

Liability

Amortization

(S/L)

Ending Asset

(Finance) Amortization**

Ending Asset

(Operating)

- 449,746 449,746 449,746

1 100,000 22,487 372,233 89,949 359,797 81,594 368,152

2 102,000 18,612 288,845 89,949 269,848 85,469 282,683

3 104,040 14,442 199,247 89,949 179,898 89,639 193,045

4 106,121 9,962 103,089 89,949 89,949 94,118 98,926

5 108,243 5,154 - 89,949 - 98,926 -

Total 520,404 70,658 449,746 449,746

Liab amort. =

Rental - int exp

S/L Rent Exp = $104,081 ($520,404/5 yrs)

Yr 1 Amortiz. = $104,081 - $22,487

** Diff. b/t S/L rent expense & interest

expense on the liability

Lease Liability RoU Asset (Finance Lease) RoU Asset (Operating Lease)

PwC

Illustration—Finance vs. Operating

7

Year

Total Expense

(Finance)

Total Expense

(Operating) Difference

- - - -

1 112,437 104,081 8,356

2 108,561 104,081 4,480

3 104,391 104,081 311

4 99,912 104,081 (4,169)

5 95,104 104,081 (8,977)

Total 520,404 520,404 0

Interest Expense &

Amortization Expense

Single

Lease Expense

Total Expense Summary (Finance vs. Operating)

PwC

Identifying a lease

8

An identified asset The right to control use of the asset during the term

Is explicitly or implicitly specified

Supplier has no practical ability to substitute or would not economically benefit from substituting

Decision-making authority over the use of the asset

The ability to obtain substantially all economic benefits from the use of the asset

Lease is present in a contract if the contract includes both:

PwC

Identifying a leaseThe new critical determination

9

“A contract (or part of a contract) that conveys the right to use an asset for a period of time in exchange for consideration”

Leases could be

embedded in other

contracts

• Service contracts

• Logistics agreements

• Data center / colocation arrangements

PwC

What’s an “identified asset”?

10

Generally, it’s an asset that must be used to fulfill the terms of the contract

Identified asset

Right to Control

• Contract explicitly identifies the asset

• Typically considered “identified asset”

Explicitly specified

• Asset may also be implied by contract

• E.g., the only asset that can be used to fulfill contract

Implicitly identified

• Consider impact on “identified asset” determination

• Such rights must be substantive

Substitution rights?

PwC

What about substitution rights?

11

If supplier has the substantive right to substitute the asset during the contract, it’s not an “identified asset”

Identified asset

Right to Control

Practical ability to substitute

Customer cannot prevent substitution

Alternative assets readily available to substitute

Economic benefit from substituting

Benefits exceed costs

Consider location of assets

Substantive substitution rightsSupplier must have both:

PwC

Evaluating substitution rights

12

Evaluation made at inception of contract

Excludes circumstances not reasonably expected at inception of contract

If customer cannot readily determine, must treat substitution right as non-substantive

A right or obligation to substitute the asset only if asset is damaged or obsolete does not preclude having an identified asset prior to substitution

Identified asset

Right to Control

PwC

What’s the “right to control”?

13

Identified asset

Right to Control

Le

as

e

A customer has the right to control the use of an identified asset if it has the right to both:

(a) Obtain substantially all the economic benefits

from use of the asset

(b) Direct the use of the asset

PwC

What’s the “right to control”?

14

Le

as

e

Identified asset

Right to Control

(b) Direct the use of the asset

(i) Customer has the right to

operate the asset (within scope of its right to use)

• Consider decision-making rights most relevant to changing how/for what purpose asset is used

• Examples include right to change:• The type of output produced• When / where output is produced• Whether output is produced & quantity of output

(ii) Customer designed the

asset (or specific aspects) in a way

that predetermines

either:

• How / for what purpose the asset will be used; or• How the asset will be operated

Le

as

e

PwC

What’s the “right to control”?

15

Le

as

e

Identified asset

Right to ControlL

ea

se

(b) Direct the use of the asset

Other items to consider:

Customer’s ability to specify the output in a contract without any other decision-making rights is not a lease

A supplier’s protective rights do not, in isolation, prevent customer from having right to direct the use of the asset

Decision-making rights around maintaining, insuring, &/or operating the asset do not grant right to change how/for what purpose used

PwC

What about separation & allocation?

16

Le

as

e

1. Identify all separate lease components within the contract

2. Allocate consideration to each separate lease component & the non-lease components***

3. Account for each separate lease component separately from the non-lease components

After determining a contract contains a lease, entities must separate lease & non-lease components as follows:

***Practical expedient

(lessees only):

• Lessees can choose not to separate non-lease components from lease components (policy election by asset class)

• Instead account for each separate lease component & associated non-lease component as single lease component

PwC

Allocating consideration to components

17

Le

as

e

Lessee • Allocate based on relative standalone prices

Lessor • Allocate using requirements in ASC 606

Components include only items/activities that transfer a good or service to the lessee

• Consequently, reimbursement or payment of lessor’s costs (e.g., taxes, insurance) are not separate components:• No separate allocation made to such elements• Instead, include as part of the lease component

PwC

Other notable items…

18

Le

as

e

Build-to-suit (BTS)

• No more prescriptive BTS guidance• Transition guidance for existing failed

BTS transactions

Sale-leasebacks (SLB)

• Use ASC 606 to determine whether sale has occurred

• No sale if leaseback classified as finance lease

• Symmetrical buyer-seller treatment

Lease modifications

• Specific guidance for determining mod vs. new lease

• Guidance on how to account for mods

Combining contracts

• Specified guidance for determining when to combine contracts (similar to ASC 606)

PwC

Lessee disclosures

19

Qualitative

• General description of leases (& subleases)• Existence of extension, termination, & purchase options, RVGs,

variable lease payments• Significant judgments & assumptions

• E.g., determining whether contract is or contains a lease, separation/allocation, discount rate, etc.

• Leases that have not commenced but create significant rights / obligations

• Accounting policy elections• E.g., short-term leases, separating lease components, etc.

Quantitative

• Finance lease cost (segregated b/t interest & amortization)• Operating lease expense• Short-term & variable lease cost• Sublease income• Gains / losses from SLBs• Cash payments & supplemental noncash info• WA remaining lease term & disc rate

PwC

What about transition?

20

Practical expedients

No need to reassess:

**These reliefs must be elected

as a package

• Whether expired or existing contracts contain a lease

• Classification of expired or existing leases

• Amount of IDCs for existing leases

Can also elect to use hindsight when determining the following (with or without electing the package reliefs above):• Determining the lease term• Exercise / non-exercise of extension, termination, & purchase options

PwC

Overview - IFRS 16 vs. ASC 842

21

PwC

Transition

22

PwC 23Confidential Information for the sole benefit and use of PwC’s Client.

Our UnderstandingCompanies are planning for a complex and critical transition as a result of the standard…

We’ve developed an approach to help you meet the challenges of this unprecedented change to reflect leases on the balance sheet. Our process, supported by a robust suite of tools, accelerates your transition to the standard and adds value to your company.

Cost effective approach to capture leases and data driven impact analysis leveraging Lease accounting specialists

The right solution for your business that unlocks business value beyond compliance

Long term solution (people, process, and technology) that is sustainable and adaptable by your organization

Reporting, implementation, accounting analysis and change management strategy

Successful transition through establishing sustainable processes, training and implementing the right software

Lease Operating Model based on your vision and lease landscape to drive business value

Business and technical requirements that will form the basis for software selection

Part 1: Impact Assessment Part 2: Designing the Path Forward Part 3: Implementing the Standard

PwC surveyed executives across a wide spectrum of industries to gain their perspective and learn more about their approach.

~80% of Energy Companies surveyed have either begun or will start implementing the

standard in 2016

6 of 7 implementation areas (Data collection, systems, controls, tax impacts,

resources, and disclosures) were deemed to be “somewhat to very difficult to

implement”

80% of Energy companies surveyed use MS Excel to track a limited subset of their

leases….

PwC 24Confidential Information for the sole benefit and use of PwC’s Client.

Impacts and OpportunitiesBeyond compliance there are external and internal adoption impacts that increase complexity and, potentially, increase cash flow. This requires effective and efficient cross-functional processes with appropriate controls.

Renegotiate Leases

Synthetic Lease

LeaseCo•Tax Savings•BEPS•I/C Notes•Simplified workflow

Debt Covenants with Static GAAP

Other Fin Statement Userso Customerso Investor Relationso FP&Ao Executive Comp

Tax

Compliance Requirements

Operations, Tax, Treasury, Finance, Accounting, HR, IR,

and FP&A

PwC 25Confidential Information for the sole benefit and use of PwC’s Client.

New Lease Standard ApproachOur ‘end-to-end’ lease strategy is tailored using a toll gate process at each phase minimizing risk and maximizing value

Part 1: Impact Assessment Part 2: Designing the Path Forward

Part 3: Implementing the Standard

*One of each type of lease

1A . Lease Sample Review*

2A. Technical Accounting Review

2B. Develop Lease Operating Model &

Roadmap

• Business Drivers• Cash Savings• Reporting• Requirements

5. Go-Live

• Test• Train

4. Design/Construct &Implement

6. PMO/ Change Management

3A. CompleteSystem Selection

• Enterprise Technology

• Licensed Bolt-on

• Non Licensed Bolt-on

3B. Finalize Roadmap

1C. Decision Support

1B. All Lease Capture

PwC

Demonstration Placeholder: Automated Data Extraction

Summary Section showing status of document

loading, term extraction and review

Interface that allows for review, verification and/or rejection and correction of

extracted terms

Machine learning capabilities will allow for

increased efficiency

PwC

Demonstration Placeholder: Interactive reporting

Provides visibility into metrics within the lease portfolio

Identifies distribution of leases amongst business units or

markets

Approximate financial impact for

GAAP and IFRS

Additional insight to operational

opportunities

28PwC

Q&A

© 2016 PricewaterhouseCoopers LLP. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP US, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

PwC

Appendix

29

PwC

Potential Opportunities Beyond Compliance

30

The new standard will bring focus to a company’s lease portfolio and create opportunities to consider strategies to decrease costs while maintaining compliance with the new regulation.

Decrease Costs• Value key lease decisions • Monitor borrowing costs to lock in the optimal interest rates • Automate the lease life cycle and accompanying journal entries • Reassess tax characterization and treatment of lease portfolio

Comply• Implement controls to monitor adherence to new regulation • Provide effective training to assist your people in executing new

processes with confidence • Use the right technology platform to capture data accurately and

safely

The FASB requirement for “comparables data,” coupled with the opportunity to gain competitive advantage, is motivating companies to start working toward successful implementation now.

Implementation of the new lease standard will require timely and complex cross-functional coordination including IT, treasury, contract management, procurement, legal, tax, internal control, internal audit, HR, and investor relations

StrategyEvolve the leasing strategy to enable compliance and maximize value

ProcessBuild processes and

controls to effectively adopt new standards and

assess impacts on processes

TechnologyChoose the optimal

technology platform for executing your strategy

and implementing efficient processes

PeoplePromote adaptability

through clear roles and responsibilities, adequate

training, and enhanced cross-functional teaming

PwC

End-to-end program considerations

31

Understanding the range of impact and complexities during lease adoption planning allows a holistic understanding of business requirements.

Program management

Accounting oversight

Process & controls

management

Systems implementation

Organizationalchange

management

Datamanagement

• Understand the lease data landscape, source quality, gaps, and maintenance

• Develop plans to gather ‘unstructured’ data if available only in contracts and not in tracking systems currently in use

Focus on…

• Data baseline (‘what’s our universe’)

• Data plan related to gaps

• Data integration into A2R and R2R process points

• On-going data maintenance

• Understand and document the Accounting policy touch points along the Acquire to Retire and Close to Report cycle continuum

• Determine changes to operating and SOX controls and policy/procedure manuals

Focus on…

• Lease vs. buy process decision points

• Contracting/buyer process controls

• Vendor process integration

• CAPEX budgeting & forecasting

• Loan covenants, credit ratings, and other agreement tracking

• Facilitate the future state process to enable capabilities working with Operations, Tax, and Accounting

• Lead the overall implementation of the solution and provide inputs to IT

Focus on…

• Reliance on spreadsheets

• Reporting and analytics

• Tracking system integration to GL and sub-systems

• Determine the organizational impacts, training strategy, and post-go live support model

• Employee mobilization, training, and knowledge transfer

• Develop and execute against a communication strategy

Focus on…

• Income & Indirect Tax

• Treasury

• Investor Relations

• Internal audit

• Outsourced providers

• Ensure accounting policy alignment across the organization

• Ensure accounting inputs into data sourcing, calculations, and outputs

• Review business requirements and functional design specifications

Focus on…

• Reassessment plan

• Management judgments

• Additional disclosures

• Transition considerations

• Tax implications

PwC

3. Cleanse & Validate

PwC’s Data Accelerator

32

Our approach is designed to aid in digitizing leases as a foundation for enabling insight into your lease portfolio. This includes gathering data for operational and financial analytics and reporting, and for migration to an end solution

Extract clauses and key terms from contracts

Create central repository of contracts and

terms

Import source documents

Assess data to determine sustainable

solution for lease management

Accounting: Financial impact modeling, policy development, etc.

Procurement and Real Estate: Operational insights and benefits

PwC’s DataSiv PwC’s Navigator

Data Identification and MappingData Extraction (Collection)Overall Project Management

Data Quality and CleansingTechnical Accounting Guidance

Financial ModelingLease Portfolio Analysis & Reporting

Operational Insights ProcurementStrategic Decision Support

Se

rv

ice

sD

ata

Flo

wT

ec

hn

olo

gie

sA

ud

ien

ce

O

utp

ut

Perform analysis and produce reports

Digitized Leases

2. Scope & Gather

PwC

Cross Functional Implementation

33

To minimize rework, understand and strategize for cross functional input, processes and outputs. This will be needed for system selection and implementation

Tax• One legal entity (LeaseCo) for

all leasing enabling visibility and unified control of all leases, may have tax implications

• Intercompany balance / reorganization

Operational Acct.Lease life-cycle and

accompanying journal entries, disclosures, KPIs, budgeting /

forecasting, investor relations, customers

Operational Acct. & Technology

Design intercompany transactions to efficiently and

effectively report for GAAP and tax purposes

TreasuryMonitor leases and borrowing costs to lock in

the optimal interest rates,

debt covenants

OperationsLease vs. buy

decision, lease portfolio

optimization, stakeholder

communication and awareness

TaxNew book-tax

differences, state taxes, reassess tax characterization

Corporate FinanceExtend the term of existing operating leases to soften the increase in expense

when shifting to balance sheet recognition

Technology Choose the optimal

technology platform for

executing your strategy and

implementing efficient processes

Internal AuditReview and create

new controls to ensure adherence to new regulation and accurate data

capture

HR / Change ManagementRoles and responsibilities, awareness / training, compensation and

bonus structures

Digitized Leases

PwC

Questions

34

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act,in reliance on the information contained in this publication or for any decision based on it.

© 2016 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers LLP which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.