KPMG’s CFO Financial ForumFinancial Forum Webcast FF...KPMG’s CFO Financial ForumFinancial Forum Webcast A Detailed Look at the FASB/IASB Revised Leases Exposure Drafts – Part

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KPMG’s CFO Financial ForumFinancial Forum WebcastA Detailed Look at the FASB/IASB Revised Leases Exposure Drafts – Part I (Scope, Definition, and Lease Classification)

June 13, 2013

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Slides

Defining Issues

Issues In-Depth

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Agenda

Scope

Definition of a lease

Agreements with lease and non-lease components

Agreements with multiple leased assets

Lease classification

Question & answer session


Polling Question #1

Is the organization you represent primarily a lessee, a lessor, or both?

A. Lessee

B. Lessor

C. Both


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Scope

Within scope Scope with exceptions Outside scope

L f t L f Leases with service components

Short-term leases (≤ 12 months with no purchase option)

Leases of assets

Long leases of land

Sale-leasebacks

Subleases

In-substance purchases / sales

Leases of inventory

Leases of:

Intangibles (other than ROU assets)

Natural resources and exploration

Biological assets


FASB/IASB LEASES PROJECT

Short-Term Leases

A lease contract that does not include a purchase option at any exercise price and for which the longest possible term is ≤ 12 months

Lessee Policy election by class of underlying assets to not recognize lease

assets or lease liabilities

Recognize lease payments in P&L over term on a straight-line basis

Lessor

Policy election by class of underlying assets to not recognize lease receivables and residual assets

Continue to recognize the leased asset

Recognize lease payments in P&L over lease term (generally straight-line)


line)

Leases cancelable by both lessee and lessor

Leases in which the lessee and the lessor each have a right to cancel the lease at any point in the future without a significant penalty (i.e., with only a nominal charge) would meet the definition of short-term leases when the notice period, together with any initial non-cancellable period, is less than one year.

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Polling Question #2

Which of the following would qualify as a short-term lease?

A. A lease of equipment for 1 month that automatically renews until canceled by the lessee

B. A lease of equipment for 12 months that includes no options to renew the lease and no purchase option

C. A lease of equipment for 10 months, without any renewal options, that includes an option for the lessee to purchase the equipment at fair market value at the end of the lease term

D. A lease of equipment for 15 months that can be terminated after 1 month without penalty


Polling Question #2 – Answer

The correct answer is B.

The lease in option B has a maximum possible term of 12 months or less. Options A and D have a maximum possible term of > 12 months The lease inOptions A and D have a maximum possible term of > 12 months. The lease in option C contains a lessee purchase option so would not qualify as a short-term lease regardless of the maximum possible lease term or the likelihood that the purchase option would be exercised.


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Lease Definition

A contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.

Definition focuses on control of an identified asset.

Supplier cannot substitute an asset

Asset must be physically distinct – applies to distinct portions but not generic capacity

Use of identified

asset


Ability to make decisions that most significantly affect economic benefits derived from use

Ability to derive substantially all of the potential economic benefits throughout contract term

Right to control use


Example #1: Lease Definition – Determining if There Is an Identified Asset

Example:

Mocha Liquid enters into an arrangement for a storage service that involves the use of a refrigerator for coffee beans.

The supplier has the right to substitute the refrigerator without Mocha Liquid’s The supplier has the right to substitute the refrigerator without Mocha Liquid s consent.

The supplier has many identical refrigerators that are maintained in a single, accessible location and the supplier could easily substitute another unit for the refrigerator in the contract at a nominal cost.

Would this contract contain an identified asset under the revised lease accounting Exposure Drafts?


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Example #1: Lease Definition – Determining if There Is an Identified Asset (continued)

Solution:

Fulfillment of the contract would not be considered dependent on an identified asset because the substitution right is substantive (i.e., the supplier has the right to substitute the refrigerator without Mocha’s consent and there are no economic gor other barriers to the supplier exercising its substitution right). Therefore, this contract is not (or does not contain) a lease.


Polling Question #3

Following on from the previous example, would the contract depend on an identified asset if the refrigerator is significantly customized and located in an isolated area?

A. Yes

B. No


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The correct answer is yes.

The substitution right would not be substantive if the cost of similarly customizing and/or delivering an alternative unit would create an economic or operational barrierand/or delivering an alternative unit would create an economic or operational barrier to substitution. Therefore, fulfillment of the contract would depend on an identified asset.


Example #2: Lease Definition – Controlling the Use of an Identified Asset

Example:

Customer enters into a time charter contract with Shipowner for transportation of cargo on a named ship for a period of 5 years. Customer determines the cargo to be transported, and the timing and location of delivery.

Customer pays a daily hire rate for the use of the ship and navigation and cargo management services (including the use of the ship’s captain, crew, and equipment). Customer does not pay for hire when the ship is off-hire (i.e., unavailable for use due to maintenance or repairs). Customer can decide when the ship is off-hire if the specified conditions for doing so under the time charter are met.

Shipowner pays for the costs of the ship when it is off-hire and remains responsible for the navigation and condition of the ship. Shipowner is also responsible for maintenance and overhaul, cleaning services relating to the cargo space, regulatory

li tt f hi f t d f th h it i b d it hi


compliance on matters of ship safety, and for the cargo when it is onboard its ship. Shipowner pays for all operating expenses of the ship, while Customer pays for the fuel used by the ship (except when the ship is off-hire) and for the port costs.

Would this contract meet the definition of a lease in the revised lease accounting Exposure Drafts?

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Example #2: Lease Definition – Controlling the Use of an Identified Asset (continued)

Solution:

The contract contains a lease based on the following:

The contract’s fulfillment depends on an identified asset (i.e., the named ship)

C t t l th f th hi Customer controls the use of the ship:

- Customer directs the use of the ship because it determines when it is on or off-hire, and the ship’s crew is under Customer’s control when on-hire, meaning Customer can determine when and where the ship carries cargo; and

- Customer has the right to obtain substantially all of the potential economic benefits from use of the ship during the contract term because no other party can utilize the ship during the contract term (e.g., Shipowner cannot use the ship to transport another customer’s cargo when Customer is not using the ship or when it is off-hire).


Polling Question #4

Following on from the previous example, would the contract meet the definition of a lease if Shipowner could use the ship to transport another customer’s cargo when Customer is not using the ship or when it is off-hire?

A. Yes

B. No

C. It depends


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The correct answer is C – it depends.

If the proportion of the arrangement term that Customer is not using the ship is expected to be insignificant it is likely that the contract would meet the definition ofexpected to be insignificant, it is likely that the contract would meet the definition of a lease. Otherwise, if there are significant economic benefits that would accrue to shipowner from operating the ship when Customer is not using it, the contract may not meet the definition of a lease because Customer does not control the use of the ship throughout the contract term.


Agreements with Lease and Non-Lease Components

Lessee Lessor

When there is an observablef

Separate and allocate Always separate and standalone price for each component

based on relative standalone price of components

allocate using the revenue recognition standard’s guidance (i.e., on a relative selling price basis) When there is an observable

standalone price for one or more, but not all, components

Separate and allocate using the residual method

When there is not an observablet d l i f f th

All lease


standalone price for any of the components in the arrangement

Assets incidental to the delivery of specified services

All service


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Example #3: Separation and Allocation of Contract Consideration to Lease and Non-Lease Components

Example:

Lessor leases a specialized machine for two years, and provides consulting services to help Lessee effectively use the machine in its production processes.

The machine is not sold or leased separately by Lessor and there are no similar The machine is not sold or leased separately by Lessor and there are no similar machines for sale or lease from other suppliers. Lessor estimates the standalone price to lease the machine would be $160,000.

Similar consulting services are sold on a standalone basis for $40,000 by alternate service providers.

The contract is for fixed consideration of $100,000 for the first year and $80,000 for the second year. The lower second-year price is based on the assumption that Lessor will provide more consulting services in the first year.


How would Lessor and Lessee each separate and allocate consideration to lease and non-lease components of this contract (i.e., the machine and the consulting services, respectively)?

Example #3: Separation and Allocation of Contract Consideration to Lease and Non-Lease Components (continued)

Solution:

Lessor is required to separate the lease component from the non-lease component.

Lessee will separate the lease component from the non-lease component Lessee will separate the lease component from the non-lease component because there is an observable standalone price for one of the two components.

Component

Stand-alone Price

AllocatedConsideration

Lessor Lessee

Machine lease $160,000 E $144,000 $140,000

C lti i 40 000 O 36 000 40 000


Consulting services 40,000 O 36,000 40,000

Totals $200,000 $180,000 $180,000

E – Estimated standalone price.O – Observable standalone price.

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Polling Question #5

Which party to a lease contract must separate lease from non-lease components in all circumstances?

A LesseeA. Lessee

B. Lessor

C. Neither party



The correct answer is B – the lessor.

The Boards’ proposals presume that a lessor should always be able to separate payments made for lease and non lease components because it would need topayments made for lease and non-lease components because it would need to have information about the value of each component to price the contract. In addition, the Boards decided that application of the forthcoming revenue recognition guidance would ensure consistency for entities that are both a lessor and a seller of goods or services within the same contract.


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Agreements with Multiple Leased Assets – Identifying Separate Lease Components

Lessor Lessee

A leased asset is a separate lease component if it is distinct, which requires

A leased asset is a separate leasecomponent if:component if it is distinct, which requires

that both:

The lessee can benefit from use of the asset either on its own or together with other readily available resources; and

The leased asset is not highly dependent on or highly interrelated with other underlying assets in the contract

component if:

It is distinct (same criteria as for lessors); and

There are observable standalone prices1

for the leased asset or for all of the other leased assets in the contract2


1Observable standalone prices are those charged by the lessor or a similar supplier for a good or service or a similar good or service when sold separately.

2A leased asset for which the lessee does not have an observable standalone price would be combined with any other lease and/or non-lease elements for which the lessee does not have an observable standalone price.

Example #4: Identifying Separate Lease Components

Example:

Lessor leases three items of heavy machinery (a bulldozer, a truck, and an excavator) to Lessee to be used in Lessee’s mining operations.

Lessee can benefit from each of the three machines on its own or together with Lessee can benefit from each of the three machines on its own or together with other readily available resources (e.g., Lessee could readily lease or purchase an alternative truck and/or excavator to use alongside the bulldozer).

Despite the fact that Lessee is leasing all three machines for one purpose (i.e., to engage in mining operations), the machines are not highly dependent upon, or highly interrelated with, each other because the machines are not inputs to a combined single item for which Lessee is contracting, and none of the machines is significantly modifying or customizing another.


How would Lessor and Lessee each determine the separate lease components in this contract?

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Example #4: Identifying Separate Lease Components (continued)

Lessor Solution:

Lessor concludes that the lease of each underlying machine is a separate component for accounting purposes (i.e., there are three lease components).

Lessee Solution:

Lessee will reach the same conclusion as Lessor as long as there are observable standalone prices for at least two of the three equipment leases; otherwise it will have to combine those lease elements for which standalone prices are not observable.


Example #5: Identifying Separate Lease Components

Example:

Lessor leases a gas-fired turbine plant to Lessee so that it can produce electricity for its customers.

The plant includes the turbine a building that exists only to house the turbine and The plant includes the turbine, a building that exists only to house the turbine, and the land on which the building is located. The building has been designed for use only with the turbine, has a similar useful life, and has no alternative use.

How would Lessor and Lessee each determine the separate lease components in this contract?


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Example #5: Identifying Separate Lease Components (continued)

Solution:

The lease of the turbine, building, and land would be treated as a single lease component for accounting purposes by both Lessor and Lessee based on the following evaluation, indicating that the underlying assets are not “distinct”:g , g y g

- Lessee can benefit from the turbine on its own (evidenced by fact that manufacturer sells turbines separately) or together with other readily available resources because the turbine could be housed in a different building on other land.

- Lessee benefits from the land and building together as a single unit (i.e., an entity cannot benefit from the building without the land on which it is located).

- However, the turbine, the building, and the land are highly interrelated because the turbine, building, and land are each inputs to the customized combined item for which Lessee has contracted (i.e., a gas-fired turbine plant that can produce


( , g p pelectricity for distribution to Lessee’s customers).

Lease Classification Tests*

Is the underlying asset property(land and / or a

building)?No Yes

Lease term for a major part of the remaining economic life; or

building)?

Type A lease** Type B lease**

Unless Unless

Lease term for an insignificant part of the total economic life; or


PV of the lease payments amounts to substantially all FV of underlying asset

PV of the lease payments insignificant compared to FV of underlying asset

* Lease classification would be performed only at lease commencement or upon lease modification.** If the lease includes a purchase option that the lessee has a significant economic incentive to exercise, it would always be classified as a Type A lease.


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Classification of Leases with Multiple Underlying Assets

Primary asset

Applicable lease term test based on life of primary asset− Primary asset – predominant asset for which the lessee

Property vs

entered into the contract− Non-primary assets – enable lessee to obtain benefits of

the primary asset

Land and building = single item

No allocation of payments between land and building

vs Non-property

L d d


p y g Economic life of building = economic life of property for

lease term test In some cases may result in lease income/ expense

recognized on an accelerated basis

Land and building


Example #6: Lease Classification – Property+

Example:

Lessor and Lessee enter into a 15-year lease of a storage warehouse, which has a remaining economic life of 40 years at the lease commencement date.

The present value of the lease payments is $300 000 The present value of the lease payments is $300,000.

The fair value of the property at the lease commencement date is $400,000.

How would Lessor and Lessee classify this lease (i.e., Type A or Type B)?


+ Based on Example 12 in proposed FASB ASC Subtopic 842-10 of the 2013 FASB ED and Example 13 of the 2013 IASB ED.

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Example #6: Lease Classification – Property (continued)

Solution:

The lease would be classified as a Type B lease because the underlying asset is property and:

The lease term of 15 years is for less than a major part (37 5%) of the remaining The lease term of 15 years is for less than a major part (37.5%) of the remaining economic life of the property, and

The present value of the lease payments represents less than substantially all (75.0%) of the fair value of the property at the lease commencement date.

The Boards have not defined “major part of the economic life” or “substantially all” for purposes of evaluating lease classification. Therefore, how much higher the


p p g , gthresholds for major part and substantially all would be than the benchmarks illustrated in the Boards’ example is likely to be the subject of future interpretive debate.

Example #7: Classification of a Lease with Multiple Underlying Assets

Fact pattern for example:

Lease of laboratory (integral) equipment, laboratory building, and underlying land

Underlying assets comprise a single lease component

Laboratory equipment is primary underlying asset

Lease term 5 years

Total economic life of laboratory equipment 10 years

Remaining economic life of building 25 years

Present value of minimum lease payments $ 375,000

Fair value of underlying assets in aggregate $1,000,000

No rene al or p rchase option / title transfer in lease agreement


No renewal or purchase option / title transfer in lease agreement

ED’s Proposals – Type A Lease

Lessee: Accelerated ROU Model

Lessor: R&R Model

ASC 840

Lessee: Operating lease

Lessor: Operating lease


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Polling Question #6

What is the appropriate basis upon which to determine which asset in a single lease component with multiple underlying assets is the “primary asset”?

A The asset with the highest lease commencement date fair value is always the primaryA. The asset with the highest lease commencement date fair value is always the primary asset

B. The asset with the longest remaining economic life is always the primary asset

C. The asset with the longest total economic life is always the primary asset

D. The predominant asset for which the lessee entered into the lease contract is always the primary asset



The correct answer is D.

The 2013 EDs propose that the primary asset in a lease component that contains multiple underlying assets would be the predominant asset for which the lesseemultiple underlying assets would be the predominant asset for which the lessee entered into the lease contract.


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Question & Answer Session

Presenters’ contact details

Kimber K. [email protected]

Scott A. [email protected]


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The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 26120NSS

The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

Documents

KPMG’s CFO Financial ForumFinancial Forum Webcast FF...KPMG’s CFO Financial ForumFinancial Forum Webcast A Detailed Look at the FASB/IASB Revised Leases Exposure Drafts – Part