Dataline A look at current financial reporting issues - PwC

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Topic Initial ED Revised ED PwC observations Presentation — Income statement for lessees A lessee should recognize amortization of the right-of-use asset (straight-line), and interest on the liability to make lease payments (effective interest rate). The result is a front loading of expense in the income statement. Under the I&A approach, a lessee should recognize interest expense and amortization expense separately in the income statement. Under the SLE approach, a lessee should recognize lease expense as one amount in the income statement. Due to the variety of changes to the income statement (i.e., interest expense, amortization expense, etc.) lessees applying the I&A approach will need to assess the potential impact on covenants, compensation agreements, and other contracts. Such an assessment may require significant time. As such, we suggest companies begin the process well in advance of the effective date. The boards also proposed that the amounts be broken out on the face of the financial statements. Presentation — Income statement for lessors Under the derecognition approach, a lessor should present in the income statement interest income from rights to receive lease payments separately from other interest income. Under the performance obligation approach, a lessor should present in the income statement interest income on a right to receive lease A lessor should present: The accretion of the residual asset as interest income, The amortization of initial direct costs as an offset to interest income, and Lease income and lease expense in the statement of comprehensive income either in separate line items (gross) or in a single line item (net), on the basis of which presentation best reflects the lessor’s business model. Similar to lessees, lessors will need to assess the impact on covenants, compensation agreements, and other contracts. Such an assessment may require significant time. As such, we suggest companies begin the process well in advance of the effective date. Presentation of lease income and lease expense gross or net may depend on the lessor's underlying business model. For example, a manufacturer and lessor of equipment may elect to apply the gross method and present significant lease revenue while a financial institution may elect to apply the net method. National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com Dataline 34
Topic Initial ED Revised ED PwC observations payments, lease income resulting from satisfaction of a lease liability, and depreciation expense on an underlying asset separately, totaling to a net lease income or net lease expense. Purchase options Options to purchase the underlying asset in a lease are excluded from the measurement of the liability and the asset. A lease contract should be considered terminated when an option to purchase the underlying asset is recognized. Thus a contract would be accounted for as a purchase and sale by the lessee and lessor, respectively, when the purchase option is exercised. Lessees and lessors should include the exercise price of a purchase option (including bargain purchase options) in the measurement of the lessee’s liability to make lease payments and the lessor’s right to receive lease payments, if the lessee has a significant economic incentive to exercise the purchase option. In other words, purchase options are accounted for in the same manner as the proposed accounting for lease extension options. If a lessee determines it has a significant economic incentive to exercise the purchase option, the right-ofuse asset would be amortized over the economic life of the underlying asset rather than over the lease term. (See discussion of "In-substance Purchase.") The revised ED aligns the accounting for purchase options with the accounting for renewal options. This reflects the consistency in the economics of the following two transactions where in substance the lessee has the right to use the leased asset for its entire economic life: Six year lease of equipment with a 10 year economic life. The initial lease has a four year renewal option. At lease commencement the lessee has a significant economic incentive to exercise the renewal option. Six year lease of equipment with a 10 year economic life. The initial lease has a purchase option that the lessee can exercise in year four. At lease commencement the lessee has a significant economic incentive to exercise the purchase option. For lessors of real estate this could be a significant change. This is because upfront revenue would be recognized when a purchase option exists in a lease arrangement, even though legal title to the leased property may never pass to the lessee. National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com Dataline 35
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 and 10: Potential outcomes for lessees Star
Page 11 and 12: loss and cash flows. After much bac
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
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Dataline A look at current financial reporting issues - PwC

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