Dataline A look at current financial reporting issues - PwC

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.23 The following illustration depicts common lease examples and which expense recognition approach will apply to each type of lease. In determining which approach to apply, significant judgment will be required for those property leases that fall on the borderline of significant (e.g., a 30-year lease of commercial real estate) and those equipment leases that fall on the borderline of insignificant (e.g., a 5-year vessel lease). .24 General concepts — Under the revised ED, lessees of property (including land and buildings) would be presumed to be eligible to apply SLE, unless factors suggest otherwise. Lessees of non-property (such as equipment) would be presumed to apply the I&A approach, unless factors suggest otherwise. PwC observation: The decision to introduce a new dividing line into the model is likely to generate significant interest and debate, given that one of the project's objectives was to remove the existing "bright-lines" between operating and capital leases. For lessees of non-property leases, such as equipment, the I&A approach will create the same frontloaded expense and financial ratio concerns that were raised when the initial ED was published for comment. .25 Impacts of different models — The proposal in the initial ED for all lessees to apply a financing approach sparked debate among a number of constituents who were concerned with the effect the proposals would have on earnings and key ratios. Users had mixed views about whether the expense recognition pattern would provide a better representation of the effects of leases or create a further divergence between profit and National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com Dataline 10
loss and cash flows. After much back and forth, the boards determined they could support moving away from applying a financing approach to all leases. .26 The diagram below illustrates the changes in a lessee's financial statements from the existing operating lease accounting to the initial ED and the revised ED (assuming no changes in lease assumptions or transition related impacts). Changes in expense recognition patterns from existing operating lease accounting Balance Sheet Proposed Model Single Lease Interest and Amortization in the Initial ED Expense Approach Approach Assets * Liabilities Income statement Lease expense Amortization Interest expense EBIT EBITDA EBITDAR EPS Cash flow statement Cash from ops Cash from finance *A smaller arrow indicates that although there is a change from existing operating lease accounting, the change is smaller than under the proposed model in the initial ED. .27 Application issues — Having two models and applying the practical expedient to different fact patterns is also expected to add fuel to the debate. Some of the questions this could generate include: What is meant by "substantially all"? What is meant by "insignificant"? Are they purely quantitative thresholds (e.g., 90%, 10%) or is a qualitative analysis needed? Does this fundamentally create new bright lines? Should one interpret "property" to mean land or a building, or part of a building ("international view") or to include a broader "real estate" definition ("U.S. view") that includes "integral equipment," such as cell towers? Will "fragmentation" between property and non-property items included in the same arrangement be required? For example, if there is a single contract with more than one lease element (such as land, building, and equipment) is there a requirement to break out each respective component and evaluate it separately, potentially with a different expense recognition pattern for each? National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com Dataline 11
Page 1 and 2: Dataline A look at current financia
Page 3 and 4: .4 In June 2005, the Securities and
Page 5 and 6: .9 In early 2011, the boards began
Page 7 and 8: .14 Although the project proposes c
Page 9: Potential outcomes for lessees Star
Page 13 and 14: The revised dual lessor accounting
Page 15 and 16: Financial Instruments project. Howe
Page 17 and 18: PwC observation: Judgment will be r
Page 19 and 20: Time-charter contract: A time chart
Page 21 and 22: index or rate that was applicable f
Page 23 and 24: The path forward .61 The boards are
Page 25 and 26: Topic Initial ED Revised ED PwC obs

Dataline A look at current financial reporting issues - PwC

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