Impact Of New Lease Accounting

Standards

PRESENTED BY:
AASMA NAWAB

Impact Of New Lease Accounting

Standards

Outline
Background
Objective
Existing lease accounting approach
Proposed lease accounting approach
Impact of new lease accounting standards
Summary

Impact Of New Lease Accounting

Standards

Background
A lease is a contractual
agreement between a
lessor and a lessee,
that gives the lessee
the right to use specific
property, owned by the
lessor, for a specified
period of time.

Impact Of New Lease Accounting

Standards

Who Are the Players?

Three general categories:

Banks
Captive leasing companies
Independents

Largest group of leased equipment

involves:

Information technology
Transportation
Construction
Agriculture

Impact Of New Lease Accounting

Standards

Objective Why the change?

On 16 May 2013, the International Accounting Standards Board
(IASB) and the Financial Accounting Standards Board (FASB)
(collectively, the Boards) issued exposure drafts proposing a new
accounting model for leases, which would require lessees to record
most leases on-balance sheet.
The project objective is to :

Transparency

Standardization

Accuracy

Impact Of New Lease Accounting

Standards

Existing Lease Accounting Approach

Impact Of New Lease Accounting

Standards

Existing lease accounting

approach
Under existing International Financial Reporting Standards
(IFRS), businesses account for leases or rentals either as:
Finance leases (Capital lease)
Operating leases

Impact Of New Lease Accounting

Standards

Existing lease accounting

approach

Finance Lease:
Capitalize a lease that transfers substantially all of
the benefits and risks of property ownership,
provided the lease is no cancelable.

When a lease is reported as a finance lease,

Lessee records an asset (i.e., leased equipment) and
a liability (i.e., lease payable).

In a finance lease, the lessee is usually responsible

for the executory costs.

Impact Of New Lease Accounting

Standards

Existing lease accounting

approach
Operating Lease: (Lessor)
Leases that do not transfer substantially all the benefits and
risks of ownership are operating leases.
The leased equipment is reported on the balance sheet in
Property,
Plant
and
Equipment
subsection
entitled
Equipment
Leased to Others" and record depreciation.
The lessor usually pays the executory fees and records them
as operating expenses.
9

Impact Of New Lease Accounting

Standards

Existing lease accounting approach (Lessee)

Leases that DO NOT meet any of the
four criteria are accounted for as
Operating Leases.

No
Bargain
Purchase

No
Lease Term
>= 75%

Yes

Finance Lease

Yes

Transfer
of
Ownership

No

PV of
Payments
>= 90%

Yes

Lease Agreement

No
Operating
Lease

Yes

Impact Of New Lease Accounting

Standards

The Proposed Leasing Standard

Impact Of New Lease Accounting

StandardsStandard-One Model
Proposed

The
Leases

for all

The key elements of the proposed lease accounting model and

its effect on financial statements are as follows:
The distinction between operating leases and finance
leases will be eliminated.
Risk and ownership transferred to lessee.
Leasing payments will treated like a loan.
Entities will recognize an asset and liability at the start of
a lease

Impact Of New Lease Accounting

Standards

A Comparison of Current & the Proposed Standard

Current standards

Reporting

Utility

Capital (Finance)
Lease

BS--asset
&
liability Investors & creditors use FS info for
recorded
decision making and analysis (ratios)
PL---depreciation & Interest
Exp

Operating Lease

BS---no asset or
recorded
PL---rent expense

Proposed standards

Reporting

Utility

One Model for all

Leases
(i.e. Finance Lease )

BS---Right-of-use
asset
&
liability for future lease
payments
PL---Amortization expense
interest expense

Investors & creditors have more

complete info in FS on all assets and
liabilities resulting from Leasing as well
as expected cash flows for all leases

liability Investors & creditors must adjust FS info

to reflect all assets, liabilities & finance
costs arising from operating leases

Impact Of New Lease Accounting

Standards

Impact of New Leasing Standard

Impact Of New Lease Accounting

Standards

Impact of new leasing standard

Companys performance and growth projections
Financial ratios
Additional Reporting Burden
Threat to breach of financial loan covenants
Risk of default

Impact Of New Lease Accounting

Standards
Expected impact of lease accounting standard
Balance sheet

Financial ratios

66%
55%

32%
25%

Operations

54%

34%

19%
29%
27%
28%

Income statement

27%
28%
26%

Investor relations
0%

66%

43%

10%

20%
Lesees

30%
Lessors

40%

Equipment leases

50%

60%

70%

Impact Of New Lease Accounting

Standards
Impacts on financial ratios
Debt to Equity

71%

Return on Assets

52%

Profit

40%

Interest Coverage

39%

Operating Margin
0%

23%
10%

20%

30%

40%

Impacts on financial ratios

50%

60%

70%

80%

Impact Of New Lease Accounting

Standards

Why do companies favor operating

leases?
1. 100% Financing at Fixed Rates
2. Flexibility
3. Tax Advantages
4. Protection Against Obsolescence
5. Off-Balance-Sheet Financing
6. Less Costly Financing

Impact Of New Lease Accounting

Standards

Summary
For many companies, the proposed lease accounting standard could have farreaching impacts on their balance sheet and financial ratios, such as Debt to
Equity and ROA. Both lessees and lessors are likely to face significant additional
reporting burdens. Few companies currently appear to be prepared to comply with
the proposed standard and little progress has been made at completing the
required implementation tasks.
Although the proposed standard could be approved in 2014 and to take effect no
sooner than 2017, the new proposals aim to improve the quality and comparability
of financial reporting by providing greater transparency about leverage, the assets
an organization uses in its operations, and the risks to which it is exposed from
entering into leasing transactions, according to the FASB.

Impact Of New Lease Accounting

Standards

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