FASB Investor Video: Leases - YouTube

welcome to fasb's webcast for investors on the  soon-to-be affective leasing standard the standard  

is effective beginning January 1st 2019 for public  companies and a year later for all other companies  

I'm Shandi Smith investor liaison at the fasb and  joining me today is board member Hal Schroeder how  

adoption of the standard by public companies  is right around the corner what are the big  

changes to financial reporting that investors can  expect chandi I'll cut to the chase the biggest  

change leases the property and equipment that were  reported as rent expense on the income statement  

and appeared nowhere in the balance sheet will  now be on the balance sheet as lease related  

assets and liabilities these are called operating  leases but what that means is that companies must  

identify all their leases compute the present  value or the lease payments and determine the  

amounts to be recorded on the balance sheet on  the income statement companies will continue  

to record rent expense for operating leases Lissa  is shorter than one year qualify for an exemption  

they can be expensed and not recognized on  the balance sheet but these amounts must be  

disclosed on the cash flow statement payments for  operating leases show up in operating activities  

okay so what about the accounting treatment for  leases that are already recorded on the balance  

sheet today so-called capital leases apart from  the name they're now called financing leases not  

much has changed these leases are recorded  on the balance sheet amortization interest  

expenses related to these assets is reflected  on the income statement and then the cash flow  

statement payments for principal are separately  recorded in financing activities so have the test  

to determine what is considered an operating lease  and what is considered a financing lease changed  

at all the tests were made more principal based  but still focus on determining when the transfer  

of ownership and risk have moved to the less see  if ownership and risk have transferred its the  

financing lease if not it's not burning lease okay  so let's step back for a second why did the board  

take on this project when the board was conducting  research for this standard we learned that many  

financial statement users were already making  adjustments they did this to better capture an  

S to mated one and a quarter trillion dollars in  off-balance-sheet assets and liabilities resulting  

from leasing obligations often they roughly  estimated by say multiplying a seven or some  

other multiple to rent expense to calculate an  amount for operating assets and liabilities those  

calculated amounts were then used in determining  metrics such as return on assets return on capital  

employed or leverage like investors the board  to believe they represented true assets and  

obligations that should be reflected on financial  statements they also believed users needed better  

information about leases including the terms and  amounts so I'm guessing a good way to get a sense  

of the impact to reported assets and liabilities  is perhaps to use the currently provided long term  

obligations table where companies were previously  disclosing future lease payments would you say  

that's a good starting point yeah companies  should be providing disclosures about the  

estimated impact of the new standard in advance  of the first quarter 2019 reporting but if you  

want to make your own estimate I'd start with the  long term obligations table however companies will  

likely be re-evaluating many Arrangements to  see if they contain a lease for example there  

could be arrangements that are considered service  contracts that actually contain the lease but the  

lease components were previously not identified  and recorded this could result in different  

amounts being reported than what's currently  in disclosures okay good to know so let's get  

into the nitty-gritty of how leased assets and  obligations are measured what's the discount  

rate used to discount the present value of future  minimum lease payments lessee should if possible  

use the interest rate implicit in the lease if not  they should use their incremental borrowing rate  

which is the rate of interest Alessi would have to  pay to borrow on a collateralized basis over terms  

similar to those in the lease contract a lessor  would use the the rate implicit in the lease  

itself how about variable payments so for example  when a portion of the lease cost is determined  

by percentage of sales varial payments will be  expensed when incurred and not included in the  

the right of use asset and lease out liability  also variable payments must be disclosed you  

mentioned before that short-term leases can  be expensed can you talk about that more yeah  

for cost-benefit and practical reasons the board  provided an option to expense leases with terms of  

less than one year and not to recognize them on  the balance sheet however these amounts must be  

disclosed as well as the fact that the accounting  policy was elected okay so you mentioned terms  

how are renewals considered in determining rental  terms so for example a company may have rented the  

same headquarters office space for many many years  and it doesn't plan on relocating but the lease  

is structured as a series of five year renewals  should five years be used 25 years or some other  

term there's obviously some judgment involved in  determining the lease terms the guidance says if  

renewal is reasonably certain the renewal should  be factored into the initial measurement of the  

lease but this is an area where I think there  could be more comparability issues in how its  

applied so there are disclosures such as weighted  average lease terms that are meant to help a user  

understand and possibly adjust for differences  between companies in the measurement of these  

obligations the board ultimately believed that the  lease obligations should represent the contractual  

obligation of a company and that's important  to distinguish between a company that had the  

flexibility to renegotiate or even discontinue  its lease every five years versus one that had  

locked it in for the next twenty five years the  board bleed these two situations were economically  

different all right so let's talk briefly  about lessor accounting what are the major  

standard changes under the new standard well  the quick answer is we don't expect there to  

be very many changes the board did change some  of the guidance to be consistent with revenue  

recognition guidance which may affect when and  how amounts are recognized by lessors also there  

could be additional leases identified as part  of existing service contracts for example if  

equipment is being provided as part of a service  contract it's possible the equipment may need  

to be carved out and separately accounted for  but there are no major changes to the types of  

leases that lessors will account for and these  are operating that's when they're really just  

renting out the asset direct financing think  of it as they retain the right to control the  

residual asset but the lessee controls the asset  while they're using it there's sales type leases  

this is when ownership and control is considered  to be transferred to the lessee these categories  

are similar to the existing categorization of  leases today can you remind us just at a very  

high level of the differences in accounting for  each of these types of leases sure at one end  

of the spectrum operating leases that's the  asset is kept on the books of the lessor and  

the profits are recorded over time any initial  direct cost to get the lease up and running or  

capitalized and expense over time at the other  end of the spectrum sales type leases assets  

are removed from the books and selling profits  are immediately recognized as though the asset  

have been sold initial direct cost are immediately  expensed in the case of a manufacturer the asset  

being sold any retained interest in the lease is  recorded as net investment in the lease receivable  

direct financing leases are similar to sales type  leases the difference being that selling profit  

are booked over time of course losses are booked  immediately an initial direct cost or capitalized  

as part of the net investment in the lease and  expensed over time okay thanks how so the ISB  

decided to take a different approach under Aris  lessees will record the assets and liabilities for  

all leases on balance sheets this part is similar  to US GAAP however a major difference is that all  

leases under efforts will reflect amortization  and interest on the income statement this will  

cause differences between US GAAP and interests  and widely used metrics such as eBay da and it  

will result in a different pattern of reported  income over time as more interest is reported  

in earlier periods under if rest's whereas  US GAAP will reflect straight-line expense  

for operating leases can you explain the board's  rationale for this health sure the IASB disagreed  

with the FASB his conclusion that some leases are  just rentals of equipment and thus should we be  

reflected as rent expense for lessor accounting  the IASB has two types of leases operating and  

financing operating leases will be treated similar  to operating leases under US GAAP financing leases  

are treated for the most part like sales type  leases under US GAAP with the asset being removed  

from the books in any residual amounts being  recorded as net investment in the lease revenue  

and cost of sale are booked at least commencement  under IFRS when a lessor did not manufacture the  

equipment it is leasing but it is transferring  most of the benefits and control the lease is  

treated in a manner similar to a direct financing  lease under US GAAP with recognition of profit an  

initial direct cost over time now sometimes  non lease components and lease components are  

both included in a single contract for example if  you combine let's say equipment with service what  

are the rules about treatment of those non lease  components ok lessors and lessees must determine  

whether a contract contains an on lease component  for example a maintenance services along with the  

lease component this is similar to identifying  different performance obligations and revenue  

recognition if multiple components exist they must  be accounted for separately total consideration  

the contract is allocated between the lease and  non lease components property taxes and insurance  

are not separate components so are allocated to  the lease and non lease components of necessary  

however there are exceptions of both lessees and  lessors they can elect not to separately account  

for lease and non lease components for lessors  there are criteria that must be met to make this  

election are there any tax implications of the new  standard to the extent profits are being deferred  

on the books relative to tax purposes which  would be the case for some direct financing  

leases to tax assets will increase you mentioned  earlier some additional disclosures what are the  

most significant ones personally I think the  weighted average lease terms remaining along  

with the weighted average discount rate used  to measure leases will help users understand  

differences in how leases are being measured also  separate disclosure or short term and variable  

lease cost will provide a better understanding  of a company's lease obligations and how both  

short-term and variable lease payments relate  to the total lease cost I'm sure you've already  

heard some information from companies that are  implementing the standard as we get closer to  

the effective date our company's having a  difficult time implementing the standard and  

if so what are the types of questions that the  fasb is getting when the board was finalizing  

the leases standard it was told by preparers  that retaining a two classification system  

and separate accounting for operating leases and  Finance leases for lessees would be advantageous  

that was because significant changes wouldn't  be required and the cost to implement would be  

minimal as the implementation date moved closer  preparers cited significant needs for new systems  

and expressed that they were incurring greater  costs to implement the standard than anticipated  

the FASB mitigated some of their concerns by  providing another transition method whereby  

the standard can be adopted as of the effective  date that is January 1st 2019 for calendar year  

and public business entities without reflecting  the new guidance in comparable periods under  

this transition method the disclosures under the  current guidance will still be provided as always  

the FASB stands ready to answer all implementation  questions and has been dealing collaboratively  

with it stakeholders including preparers and large  accounting firms many of the questions the staff  

have recently received which required standard  setting are specific to lessor accounting although  

we didn't intend to change lessor accounting  questions have been raised because leasing is  

a revenue generating activity so in most instances  the board tried to make the guidance between the  

leasing guide is more consistent with the revenue  recognition guidance that makes a lot of sense  

well thank you for all the information today  how and thanks to our listeners if you'd like  

more information about the leases standard or any  other phase B projects please visit www.fasb.org