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Practical implications of the joint IASB and FASB leasing project - overview

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♫ Music playing in background ♫ Welcome to this, the first, in our series of videos looking at the joint IASB and FASB leasing project. This series of videos focuses on the potential impact of the proposals for technology companies. In September 2012, after many months of joint discussions, the board's concluded that re-deliberations on the lease accounting proposals, which were originally published back in 2010. We can now look forward to a revised exposure draft in the first quarter of 2013; most likely with a 120 day comment period. After a long period of re-deliberations and with many twists and turns the proposals to be included in the new exposure draft are now clear; at least in outline. Central to the proposals will be the right of use model, under which all but short term leases would be on balance sheet for lessees. The goal of eliminating lease accounting as a source of off balance sheet finance has become the project's touchdown; and in most instances, the proposals achieve that goal. However, the cost of achieving this goal include additional complexity and some conceptual compromises. The proposals will introduce a new dual model for income and expense recognition. Lessees and lessors would apply a new lease classification test on a lease by lease basis to determine which model to apply. Lease classification would depend on the extent to which the underlying asset is consumed over the lease term and the nature of the underlying asset; whether it is real estate or other assets. In this first video we will look at an overview of the new leasing proposals. So let's firstly look at the definitions and proposed scope all the standard. The scope excludes all short term leases, leases with term less than one year. These leases will be accounted for in a similar manner to the current treatment of operating leases. Also, excluded from scope, are leases of intangible assets and certain other assets as they will continue to be accounted for in accordance with the specific guidance in existing standards for those assets. For many technology companies a key aspect will be distinguishing service contracts from contracts which may have embedded leases within them. The definition in the new leasing standard focuses on control by the lessee of a specified asset. The proposals also include guidance on separating arrangements; separating them out from those which include a lease and those with a non-lease component. Within scope, all other leases and that includes sub-leases, guidance on sale and leaseback transactions, and transactions which are in substance purchase or sales. I noted that the accounting treatment will depend on the lease classification, so let's take a look at the new lease classification test that will be applied to all leases in scope of the new leasing standard. This test is to determine whether to apply the Accelerated Model or the Straight Line Model. We'll look at the differences between these two models later. The test will depend on the nature of the asset, whether it is real estate or other assets, and on the proportion of the underlying asset that is consumed over the lease term. For property leases, the Straight-line Model would typically be applied - unless - the lease term is the major part of the economic life of the asset or the present value of the lease payments is substantially all of the fair value of the asset. So that's a high hurdle for property leases to be accounted for under the Accelerated approach. For other assets the accelerated approach would be applied - unless - the lease term is insignificant (relative to the economic life of the asset) or the present value of the lease payments is insignificant (relative to the fair value of the asset). So a low hurdle, most leases of other assets would apply the straight line model. To recap in many cases leases of real estate, land, and buildings will be accounted for using the straight-line model; and leases of other assets i.e. equipment would be accounted for using the accelerated right of use model. This lease classification would be assessed only at the lease commencement, or upon modification of the lease. We've distinguished between the straight line model and the accelerated model, but what is the difference? Next we'll take a look at the two models and the differences for both the lessor and the lessee, and let's look first at the accelerated approach. Firstly for the lessor - on the left hand side - we expect to see a new receivable and residual model. Under the receivable and residual model the lessor would derecognize the underlying asset, recognize a lease receivable (which initially will be measured at the present value of the estimated lease payments), and recognize a residual asset representing its rights in the underlying asset at the end of the lease term. And for the lessee - on the right hand side - the lessee will apply a right of use model, an accelerated right of use model. Under this model the lessee would recognize a right of use asset, and the lease liability. In the income statement of the lessee, the accelerated right of use model features separate presentation of itemization of the right of use asset in operating expenses, and interest expense on the lease liability. The interest expense would be higher at the beginning at the lease and lower at the end. This will lead to a front-loaded profile of the total lease expense for the lessee, and hence the name: accelerated model. We will look at an example of this model in the next video. Now let's turn to the straight line model. Again, firstly for the lessor - a revised version of the operating lease model is retained. Similar to the current operating lease accounting, the lessor will continue to recognize the underlying asset, and recognize lease income over the lease term. For the lessee - the lessee will again apply a right of use model, a straight line right of use model. Under the right of use model the lessee would recognize a right of use asset and a lease liability. The straight-line right of use model features a total lease expense as an operating expense with no interest charge presented. This will lead to a straight line recognition of the total lease expense. And hence the name straight line model. It's important to note that for the lessee, A right of use asset and the liability is recognized regardless of whether the accelerated model or the straight-line model is applied. So for the lessee the difference is not whether the leased asset is brought on to the balance sheet, but mainly the income statement impact. That's the end of this video introducing the proposed leasing models. There's a lot more to the proposals and in the next video will take a more detailed look at the proposals and consider the potential implications for technology companies. Thank you for watching this video. ♫ Music playing in the background ♫

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Posted by: christineward on Feb 16, 2016

Practical implications of the joint IASB and FASB leasing project - overview

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