FASB/IASB Meeting on Leases

Today (July 19, 2012), the FASB and IASB held a question and answer webcast with constituents concerning the decisions on lease accounting reached at the June 12 meeting. Recall that at the June 12 meeting, the boards settled on two different approaches: real property (land and buildings) would have straight-line expense on the income statement, while the expense for vehicles and equipment would be front-loaded (higher total expense in the earlier part of the lease). See my summary of the two approaches here and here. The following is a summary of today’s webcast.

There were numerous questions concerning the boards reasoning by suggesting two different approaches for real property (straight-line expense, depreciation only) and equipment (front-loaded expense, depreciation and interest expense). The presenters responded by giving an example concerning rental space at a mall leased for 3 years. At the end of the lease, because the reduction in value of the mall as a result of the vendor’s 3 year lease is insignificant, that vendor is only paying for a right to use that space, and not “acquiring” it. Because the vendor is not acquiring the asset, there is no “financing” expense, and the lease expense on the vendor’s income statement should be even in each of the 3 years (straight line expense, depreciation only). On the other hand, consider a 10 year lease on an airplane. After 10 years the airplane would have diminished in value (unlike the mall), so the vendor is paying for the right to use the airplane, and paying for financing of the piece of airplane consumed. As such, there would be higher total expense at the beginning of the lease (front-loading) because there will be depreciation and interest expense components.

Some individuals asked why the boards decided not to use the risk/reward guidelines as a distinguishing factor. They felt like if the risks and rewards of ownership are transferred, then the lease should be treated as having a financing component, and thus front-loaded. If risks/rewards are not transferred, then expense would be straight-line. The boards countered that the risk/reward guidelines focused primarily on acquisition of the entire asset, as such if the boards had followed those guidelines they would exclude those leases where the user acquires “more than an insignificant” portion but less than the entire asset, which they capture under the proposed system.

Constituents asked if the boards would define what constitutes “more than an insignificant” portion of the asset. The presenters responded that the boards were unlikely to define insignificant using numbers, but they would give numerous examples. They acknowledged that judgment would have to be used in some instances, for instance a building lease with a 30 year term, or a vehicle lease with a 5 year term. They however stated that their expectation is that in most cases the correct approach would be pretty clear.

Constituents asked if non-public companies would have the same effective date as public companies, and the presenters responded that while the effective date has not been determined yet, a provision might be made for non-public companies to adopt the guidelines at a later date.

The presenters also stated that the expectation is that early adoption will be permitted, and while the expected transition is the retrospective approach, it is not going to be fully retrospective.

Presentation on New Lease Accounting Rules

I will be presenting at the Crowe Horwath LLP Financial Institutions Conference Series on August 16, 2012. I will be one of four speakers at this event, covering various accounting and tax topics.  Specifically, I will be discussing the proposed lease accounting changes.  If you would like to attend this event, contact Laura Snyder at laura.snyder@crowehorwath.com or 404.442.1637. Click here for more information about the event.

Using Excel to Calculate the Inital Lease Liability (and ROU Asset) and to create the Accretion Table

In this blog post, I’d like to show you how to create the amortization schedule for the Lease Liability using excel. As noted in a previous post, you are going to need to prepare this amortization schedule under both the straight-line approach (leases of land and buildings) and the accelerated approach (leases of all other types of assets). There are two ways to prepare the amortization schedule:

  • method 1, where you create the amortization schedule and calculate the present value of the minimum lease payments at the same time using the goal seek function in excel (in my opinon, this is the easier method) and
  • method 2, where you first calculate the present value of the minimum lease payments, then create the amortization schedule in two separate steps.

Here is the scenario we’ll use, a 10 year lease with annual payments made in arrears as follows: Year 1 – 10: 10,000; 10,500; 11,000; 11,500; 12,000; 12,500; 13,000; 13,500; 14,000; 14,500.

Let’s assume the interest rate inherent in the lease is 6%. (In a future post I will show how to calculate this rate).

Method 1:  The amortization schedule to show accretion of the lease liability will have five columns:

A

Period

B

Cash Due

C

Interest

D

Principal

E

Balance

 

For ease of identification, let’s call them columns A, B, C, D and E for now. The period column (column A) simply identifies the year, and Column B shows the cash payments. As such, our amortization table for the lease liability looks like this so far:

A

Period

B

Cash Due

C

Interest

D

Principal

E

Balance

0

1

10,000

2

10,500

3

11,000

4

11,500

5

12,000

6

12,500

7

13,000

8

13,500

9

14,000

10

14,500

 

In period 0, put zeros under Columns B, C, D and E.  Column C (interest) is simply the rate inherent in the lease (6% in this example) times the balance at the end of the previous period (Column E of the previous period).  So in Period 1 Column C, put the following formula: “= 6%*(Period  0 Column E). In Period 2 Column C, put “=6%*(Period 1 Column E), etc.

Column D (Principal) is simply the difference between Column B and Column C, and Column E for each period is the difference between Column D for that period and Column E from the previous period. So basically, in Period 1 Column E, you would put in the following formula: “= (Period 0 Column E) – (Period 1 Column D).

Once we input all these formulas, believe it or not, our amortization table is complete. If done correctly, it should look like this:

A B C D E
Period Cash Interest Principal Balance
               –                –                –                –                  –
                1      10,000                –      10,000      (10,000)
                2      10,500          (600)      11,100      (21,100)
                3      11,000      (1,266)      12,266      (33,366)
                4      11,500      (2,002)      13,502      (46,868)
                5      12,000      (2,812)      14,812      (61,680)
                6      12,500      (3,701)      16,201      (77,881)
                7      13,000      (4,673)      17,673      (95,554)
                8      13,500      (5,733)      19,233    (114,787)
                9      14,000      (6,887)      20,887    (135,674)
              10      14,500      (8,140)      22,640    (158,315)

At the end of Period 10, the Lease Liability Balance (Column E) should be zero, so what we have to do is figure out what value at Period 0 Column E would give us a balance of Zero at Period 10 Column E. Luckily, excel has a function called Goal seek that enables us do exactly that, and it is effortless. All you do is select the cell in Period 10 Column E. Then, in your menu function, under “Data,” and then under “What if Analysis,” Select ‘Goal Seek.” A dialog box will pop up that looks like this:

Under “Set Cell”, select Period 10 Column E. In “To Value,” put Zero. In “By Changing Cell,” select Period 0 Column E. Once you hit ok, your amortization schedule will change as follows:

A B C D E
Period Cash Due Interest Principal Balance
               0                –                –                –         88,402
                1      10,000         5,304         4,696         83,706
                2      10,500         5,022         5,478         78,229
                3      11,000         4,694         6,306         71,922
                4      11,500         4,315         7,185         64,738
                5      12,000         3,884         8,116         56,622
                6      12,500         3,397         9,103         47,519
                7      13,000         2,851      10,149         37,370
                8      13,500         2,242      11,258         26,112
                9      14,000         1,567      12,433         13,679
              10      14,500            821      13,679                   0

So basically, at commencement of the lease, the lease liability (and Right-of-use Asset) is 88,402. After year 1, the lease liability will be 83,706, and at the end of year 2 it will be 78,229, etc. Note that the only time the lease liability and ROU Asset will be the same (in this example) is at the beginning and at the end of the lease. In the next post, I will show you the second method of calculating the initial lease liability.  To download an excel file that shows this amortization schedule already built, click Example-Amortization-Schedule.