This document discusses the potential implications of proposed changes to lease accounting standards for the banking industry. The changes would require lessees to record most leases as assets and liabilities on their balance sheets. This could impact banks' lending relationships by changing borrowers' financial statements and risk assessments. As lessees, banks may see increased liabilities, accelerated expense recognition, and changes to expense classifications and cash flows. The document recommends banks prepare for these changes through increased internal communication, evaluating procedures and systems, reviewing leasing and financial reporting strategies, and considering potential tax implications.
3. Introduction
Lease accounting, particularly as it relates to lessee accounting, will change significantly under current proposals
put forth in a Joint Project between the Financial Accounting Standards Board (“FASB”) and the International
Accounting Standards Board (“IASB”).
The fact that a lessee under current generally accepted accounting principles (“GAAP”) can execute a contract to
make legally binding payments over a period of time, structure the contract so that it is classified as an operating
lease and not be required to reflect that obligation as a liability on the balance sheet has been a source of
controversy for both financial regulators and analysts.
The FASB and the IASB began to tackle this issue in 2009 by issuing a Preliminary Views topic paper which was
followed by Exposure Draft in August 2010 (‘the 2010 ED”) which proposed major changes to manner in which
leases are accounted for. The 2010 ED sparked numerous comments and a lively debate among financial
statement preparers because of the perceived additional complexity that the proposed changes would entail.
The FASB and the IASB (“the Boards”) undertook significant outreach to the financial statement preparer and user
communities and in May 2013 issued a revision to the Exposure Draft (“the Revised ED”) which eliminates some of
the more complex provisions but retained most of the basic elements of the 2010 ED.
This presentation will review how we see the proposed lease changes impacting the Banking industry.
4. Background
A lease is defined as a “contract that
conveys the right to use an asset (the
underlying asset) for a period of time
in exchange for consideration”.
The lessee must be able to identify an asset or assets that can be
used and also demonstrate that the contract allows the lessee to
control the use of the identified asset for some period of time in
exchange for consideration.
5. Basic Provisions of the Revised ED
The provisions of the Revised ED require that the
financial statement preparer determine these most
important elements associated with a lease (not meant
to be all inclusive):
…the boards have
retained the
requirement that
most lease contracts
be recorded on the
balance sheet of the
lessee…
• Does the contract in question meet the definition of a
lease for accounting purposes?
• Does the contract contain any non-lease components?
• What is the lease term?
• What are the lease payments?
• How should a lease be classified?
Determining the lease term and the lease payments associated
with the lease term are significant because the Boards have
retained the requirement that most lease contracts be recorded
on the balance sheet of the lessee using a right-of-use model for
recording the right-of-use asset (“the ROU asset”) and the liability
to make lease payments
6. A major change from the 2010 ED involves
lease classification based upon the nature of
the asset being leased and how lease related
expenses are recognized.
7. Basic Provisions of the Revised ED
The Boards proposed a number of changes to the 2010 ED that are designed
to reduce complexity including:
•
The lessee can make an accounting policy election to apply the current GAAP
operating lease accounting model for those short-term leases that have a
maximum possible lease term of 12 months or less, including option periods.
•
The previous requirement to include variable lease payments has been revised to
apply only to those payments that are based on an index or a rate or that are insubstance fixed payments.
•
The requirement to include payments during an option period has been redefined
to include only those payments where the lessee has a significant economic
incentive to exercise the option.
•
Lease and non-lease components (predominantly services provided by the lessor)
would generally be accounted for separately.
8. Reassessment
After the date of commencement, the lessee may have to reassess the initial
accounting for the lease transaction if either the lease term or the lease payment
stream changes.
Circumstances that could trigger reassessment include:
• The index or rate utilized to measure the variable lease payments changes, for
example, where CPI increases are included in the lease terms and the CPI index
initially utilized changes or
• The lease contains option periods and the lessee original conclusion as the
whether there is a significant economic incentive to exercise the option changes,
like the option to renew.
The reassessment may be required at each reporting period and result in the
adjustment of the carrying amounts of the lease liability and the ROU asset.
Additionally, if the reassessment does result in a change in the lease payment stream,
the rate utilized to discount the payments may also have to be reassessed.
9. Disclosures
The Revised ED proposes a series of both qualitative and quantitative disclosures in order for the
financial statement reader to understand more completely the nature of the lessee’s lease
portfolio.
Unless separately disclosed in the financial statements, the lessee would be required to disclose
all financial statement amounts relating to the lease portfolio in the footnotes.
Qualitative disclosures would include, among other matters, significant judgments made in
applying the accounting guidance, information about the nature of the lease portfolio, including a
description of the types of leases and certain information regarding options and variable lease
payments.
Quantitative disclosures would include a reconciliation of opening and closing balances of the
aggregate lease liability separately for Type A and Type B leases (this disclosure would be optional
for nonpublic companies) and a maturity analysis of the lease liability reflecting the undiscounted
cash flows which would include a reconciliation to the ending carrying value of the lease liability.
10. Transition and Effective Date
There are two transition approaches being proposed in the Revised ED;
• Full Retrospective
• Modified Retrospective
Neither of these approaches would provide for grandfathering of existing leases.
Under both transition approaches, the lessee would be required to recognize the ROU
asset and the lease liability at the beginning of the earliest year presented with some
minor computational relief provided to those that choose the modified retrospective
approach.
The Boards have not yet proposed an effective date for the new standard but most
observers have suggested that there would be an extended implementation period
because of the significance of the changes as compared to the current GAAP
accounting requirements.
11. Banking Industry Considerations
With respect to the proposed changes to
lease accounting, the Banking Industry is
somewhat unique in that these proposed
changes will impact banks in customer
relationships with the bank as a lender and
will also impact the industry operationally
with the bank as a lessee.
12. The Bank as a Lender
Bank lending departments should consider the following action
items:
Liabilities will certainly
increase, expense
recognition will
probably be
accelerated, and
expense classifications
will probably
change, along with
cash flow
classifications
•
Relationship managers should begin immediately to discuss with
borrowers the effect that the proposed changes will have on the
borrowers’ financial statements.
•
Financial covenants will likely be impacted by the changes to the
borrowers’ financial statements.
– Debt to equity, EBITDA and other ratios will change and may
cause non-compliance with financial covenants. Lending
departments should anticipate these effects and have a plan in
place to address these compliance issues.
•
Changes to borrowers’ financial statements will affect how the risk
of the loan relationship is rated in the bank credit assessment
process. Risk managers should anticipate this issue and have a plan
in place to address the implications
13. The Bank as a Lessee
Banks that have current lease arrangements at the
implementation date will be required to recognize the
liability for these leases on their balance sheet.
Due to this change banks may experience the following:
•
•
•
•
Need to increase regulatory capital amounts
Impact to capital and leverage ratios
Changes in leasing strategies
Future tax implications
14. Current Status
The Revised ED certainly eliminated some of the complexity but many in the user community
continue to question the reasonableness of the proposals. In Roundtable meetings hosted by
the Boards, there was very little support expressed for the proposed changes.
Many of those in attendance were very concerned about the
1. complexity of the proposals and
2. the amount of effort it would take to enact the changes, particularly as it relates to lessees.
Certain FASB/IASB Board members responded to that assertion indicating that the metrics currently being utilized
to estimate the impact of operating leases was significantly faulty.
When it came to a question from a purely technical standpoint of whether a lease represented a legal obligation
on the part of the lessee, it is interesting that most of the attendees were hard pressed to argue that the liability
for lease obligations should not be recognized on the balance sheet.
So the issue may be one of how to apply this model in a less complex manner and how certain unique industry
matters will be addressed. Most commentators following the project have indicated that the project will
ultimately be finalized with lessee balance sheet recognition of most leases.
15. Recommended Next Steps
Given the delays in completion of the leasing project
and an uncertain implementation date, it is easy to
become complacent in preparing for the changes
that are most likely to be finalized.
Timely preparation is the key to an effective
implementation. Summarized below is just a
partial list of next steps that banks should be
considering in preparation for the lease
accounting changes.
16. Recommended Next Steps
#1 Increase Internal Communication
#2 Evaluate Current Procedures and Systems
#3 Review Current Leasing Strategy
#4 Understand Impact to Financial Reporting
#5 Review Potential of Tax Implications
17. Whitepaper
Download the full whitepaper on the
Implications of the Lease Accounting
Changes to the Banking Industry
18. About the Author
Sean T. Egan is Co-Founder and Managing Partner of iLease Management
LLC, the developer of iLeasePro. Mr. Egan retired from the accounting and
advisory firm of KPMG LLP after having spent 35 years with the firm as a
partner providing audit and advisory services to the financial services
industry. In 2012, Mr. Egan founded iLease Management LLC along with CoFounder and Managing Partner, John Meedzan.
Making It Easier To Manage the Entire Real Estate and Equipment Lease Lifecycle
iLease Management LLC
14 Thatcher Terrace
Farmington, CT 06032
http://www.iLeasePro.com
Sean T Egan, Managing Partner
stegan@ileasepro.com
John J Meedzan, Managing Partner
jmeedzan@ileasepro.com
19. About iLeasePro
The Management of iLeasePro is committed to keeping our constituents abreast of the status of the leasing project and
operational issues that will result from these changes. Although significant changes to accounting such as these will undoubtedly
be time consuming and disruptive, we believe that implementation of these changes should be viewed not just from an
accounting perspective but as a way for the overall organization to become more efficient. That is why, in designing iLeasePro, we
did not simply look at the project from an accounting perspective. In iLeasePro, we have a Lease Management technology
solution that is able to capture all the key data related to the lease portfolio in one central location easily accessible to all those
who have need of this information. Critical dates can be flagged so that there is never a reason to miss lease expirations or
extensions or an insurance renewal. Lease related documents can be stored electronically for easy access and reference. Contact
information regarding key personnel related to the lease can be readily accessed in our Contacts section. And these are only a few
features of our Lease Management solution.
Additionally, our Lease Analysis solution is fully integrated with Lease
Management. We understand that a technology solution is a critical
element of the entire lease cycle, not just after a lease is executed.
Lease Analysis allows the user to perform a side by side comparison of
various leasing options and provides the user with the critical analytics
to make an informed decision about the best alternative for the
organization. Once the proposed lease accounting standard has been
finalized, we are ready to integrate our Lease Accounting technology
solution into iLeasePro to complete a comprehensive and fully
integrated Lease Analysis, Management and Accounting solution.
For additional information about iLeasePro and for details as to how
you can become a Beta tester of this exciting new product, please go
to our website at http://ileasepro.com.
