Dataline A look at current financial reporting issues - PwC

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Overview of changes from existing GAAP .1 The revised ED is expected to propose a number of changes from existing GAAP. The most significant changes are included in the following table: Overview of changes in a revised ED from existing GAAP Determination of whether an arrangement is or contains a lease Lessee accounting The analysis under existing GAAP to distinguish a service from a lease will be significantly changed as a result of clarification of what is a "specified asset" and alignment of "control" indicators closer to the guidance in the proposed revenue recognition standard and the latest consolidation guidance. All leases (except short term leases) will be recognized on the balance sheet. A dual model for income statement recognition will be retained; which model will apply would be based on whether the lessee "consumes" the underlying asset. Lessor accounting A dual model for balance sheet and income statement recognition will be retained; which model will apply would be based on the same principle of consumption as for lessee accounting. Current operating lease accounting will be retained for some leases; however, the finance lease approach will be replaced with the receivable and residual approach. Lease term, Variable/uncertain cash flows, and Reassessment The revised ED will alter the threshold for including in the measurement extension options and contingencies based on a rate/index. Reassessment will be required throughout the lease term. Background of the project .2 Leasing arrangements satisfy a wide variety of business needs, from short-term asset rentals to long-term asset financing. Leases allow lessees to use a wide range of assets, including office and retail space, equipment, trucks/cars, and aircraft, without having to make large initial cash outlays. Sometimes, leasing is the only option to obtain the use of a physical asset when it is not available for purchase (e.g., it is generally not possible to buy one floor of an office building). .3 Many observers have long believed that the current lease accounting model is not consistent with the FASB and IASB's conceptual frameworks, which provide the underpinnings for their accounting standards. They argue that the model allows lessees to structure lease transactions to result in operating lease classification and therefore receive off-balance sheet treatment. Critics also point out that the current standards permit something as seemingly illogical as a commercial airline not reporting any airplanes on its balance sheet. National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com Dataline 2
.4 In June 2005, the Securities and Exchange Commission (SEC) issued its Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002 on Arrangements with Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filings by Users. One of the significant recommendations in this report was that existing lease standards needed to be rewritten, predominantly to eliminate offbalance sheet accounting by lessees. .5 As part of their global convergence process, the boards added a joint project on leases to their agendas in 2007 and have been working since to create a single, comparable, worldwide leasing standard. The project was intended to build on previous work contained in the 1999/2000 white paper titled G4+1 Special Report, Leases: Implementation of a New Approach. The initial ED published by the boards in August 2010 was a follow up to a discussion paper published in March, 2009. PwC observation: While there are some differences, the core elements of existing U.S. GAAP and IFRS for leases are largely aligned today. Accordingly, while reaching a converged standard is a key consideration, the boards' joint leasing project is more about addressing perceived problems with the existing accounting model than aligning the guidance. Overview of the initial ED The definition of a lease under current GAAP is retained. Off-balance sheet accounting by lessees for operating leases is eliminated; essentially all assets currently leased would be brought on balance sheet. Rent expense is replaced by interest expense (which would be greater in earlier years, like a mortgage) plus straight-line amortization of the leased asset, such that total expense would be "frontloaded." Traditional financial performance ratios may no longer be useful; other operating metrics may evolve. Lease assets and liabilities would be recognized based on the present value of payments to be made over the term of the lease and subsequently measured at amortized cost. The payments would include “contingent” amounts, such as rents based on a percentage of a retailer’s sales and rent increases linked to changes in the Consumer Price Index. The lease term would include optional renewal periods that are "more likely than not" to be exercised (this is substantially different than today’s model). Lease renewal periods and variable lease payments would be continually reassessed, and the related estimates trued up as facts and circumstances change (again, substantially different than today's model which is largely "set-it and forget it"). A lessor would apply the "performance obligation" approach if it retains exposure to significant risks or benefits associated with the underlying asset during or after the expected lease term; the "de-recognition" approach would be used otherwise. This is known as the "dual model." Pre-existing leases would not be grandfathered. A "modified retrospective" approach for transition would be required (i.e., treat all leases in effect as if they started at the beginning of the earliest year presented). National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com Dataline 3
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Dataline A look at current financial reporting issues - PwC

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