Overview - FASB Exposure Draft Leases (Topic 840) February 2, 2011 Douglas Boedeker, CPA, CMA

© Copyright Tate & Tryon Course Outline  Why is the exposure draft being issued?  FASB timeline  Project scope  Recording by lessees  Work through an example  Recording by lessors  Transition

© Copyright Tate & Tryon 2010 The FASB/IASB Lease Project – WHY?  Leases are an important source of finance – more information required.  Concern over lack of comparability.  Concern over “bright-line” test for operating vs. capital lease. 3

© Copyright Tate & Tryon 2010 FASB Timeline  Exposure Draft Issued – August 17, 2010  Public Comment Period Ended – December 15, comment letters were received!  Final standard currently anticipated for release sometime in 2Q2011 4

© Copyright Tate & Tryon 2010 Scope of the proposed standard Simple – ALL Leases Except : Leases of intangible assets Leases of mineral rights, etc. Leases of biological assets Distinct service components of a lease agreement should be accounted for in accordance with the new ED on revenue from contracts with customers. 5

© Copyright Tate & Tryon 2010 What is a “lease”? “A contract in which the right to use a specified asset is conveyed, for a period of time, in exchange for consideration.” 6

© Copyright Tate & Tryon 2010 Initial Recording by a Lessee 1.Determine the “lease liability” (Future anticipated cash payments discounted to present value at either the lessee’s incremental borrowing rate or the rate implicit in the contract.) 2.Determine the “right of use asset” (Lease liability plus initial direct costs of acquiring the lease.) 7

© Copyright Tate & Tryon 2010 Subsequent Recording by a Lessee  Amortize the “right of use asset”. (Probably on a straight-line basis.)  Adjust the lease liability using the effective interest rate method. (Essentially treated like a note payable.)  Reassess significant assumptions and adjust for current facts and circumstances. (Discount rate does NOT change.)  Thus, the P&L reflects amortization expense and interest expense. 8

© Copyright Tate & Tryon 2010 Items requiring judgment  The lease term to be used when recording the lease is the longest possible term that is more likely than not to occur.  Contingent rentals must be estimated up-front using a probability analysis.  Payments to be made under residual value guarantees should also be estimated and factored in to the initial lease liability.  At the end of each reporting period the following items must be reassessed and adjusted as necessary: - Lease term - Contingent rentals and residual value guarantees - Right of use asset (for impairment) 9

© Copyright Tate & Tryon 2010 Term of LeaseProbabilityCumulative Probability 5 Years45%100% 10 Years30%55% 15 Years25% Assume a tenant enters into a five year lease with two five-year renewal options. The tenant must assess the likelihood of whether each renewal option will be exercised. HINT: Always start this analysis with the longest possible term at the bottom and work your way up! 10 Determining the “lease term” A 10 year term will be used when initially recording the lease.

© Copyright Tate & Tryon 2010 Contingent Rents Let’s assume that our lease includes a provision for annual “pass-throughs” based on increases in building operating expenses and property taxes. These are anticipated to start at $50,000 per year. Our tenant’s incremental borrowing rate is 8%. 11

© Copyright Tate & Tryon 2010 Calculating the Liability and Asset Let’s assume that our lease mandates annual fixed “base” payments of $1,000,000 per year. Legal fees of $10,000 were incurred as part of the review of the lease document. Based on the lease term and contingent rental analysis performed, the liability and asset are calculated as follows……. 12

© Copyright Tate & Tryon 2010 Subsequent entries for year one 13

© Copyright Tate & Tryon 2010 Lessor Accounting Does the lessor retain significant risks or benefits of the underlying asset during or subsequent to the expected lease contract? If NO, use the “Derecognition Approach” If YES, use the “Performance Obligation Approach” 14

© Copyright Tate & Tryon 2010 Lessor Accounting – Derecognition Approach  Leased asset is removed from the books (treated like a sale, term is “lease expense” instead of COGS).  Receivable is booked for the “right to receive lease payments”.  Recognizes the bulk of revenue up front, with interest income recorded on the subsequent cash payments. 15

© Copyright Tate & Tryon 2010 Lessor Accounting – Performance Obligation Approach  Leased asset stays on books (and depreciated as usual).  Receivable is booked for the “right to receive lease payments”.  Liability (unearned revenue) is booked for the corresponding “lease liability”.  The unearned revenue is recognized over time (likely straight-line basis). Term to be used is “lease income”.  Interest income is recognized on the receivable. 16

© Copyright Tate & Tryon 2010 Transition “Simplified Retrospective Method” Determine all remaining lease payments as of date of implementation, discount, and record the corresponding asset and liability. Implementation Date Nothing definite yet, perhaps 2013 or later for nonpublic entities? 17

© Copyright Tate & Tryon 2010 Good Luck! 18