preparing for the new lease accounting standard
TRANSCRIPT
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Preparing for the New
Lease Accounting StandardRick Fisher & Will Davis
PowerPlan, Inc.
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Field OperationsCFO Office
Lease Accounting will require collaboration and integration of business and system processes across the organization
IRS: Reduced income taxes;
audit trail
Regulators: Profitable rate case
State & Local Governments:
Reduced income & property
taxes; audit trail
Debt Holders: Improved cash flow;
forecasting covenant compliance
Joint Ventures: Master Limited
Partnership K-1 filings
SEC: GAAP, IFRS; Proper asset
valuation; SOX compliance
FINANCIAL CENTRIC VIEWGeneral Ledger, Procurement, HR, Treasury, Fixed Assets, Accounts Receivable…
ASSET MAINTENANCE CENTRICConstruction WIP, Project Management, In-Service Dates, Maintenance, RetirementGeospatial data…
TaxManagement
Budget and Project
Management
AssetAccounting
Management
Asset Management
Planning
Regulatory Management
Integration Management
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Introductions
3
Will DavisProfessional Services
Rick FisherSolution Consulting
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Agenda
Lease Standard overview
Lease accounting lifecycle
Example lease agreement
Proposed adoption timeline
4
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February 25, 2016 – FASB releases Topic 840
Initially proposed in February 2006
Many iterations and tons of feedback
After diverging, IASB released a similar standard in January 2016
January 2019 mandatory adoption date
2 year lookback period
January 13, 2016
IASB releases
IFRS 17 Leases
February 25, 2016
FASB
releases final
standard
January 2017
Lookback period
for comparable
financials
January 2019
Standard effective
for most public
companies
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Leasing Standard – Major Changes
6
Operating leases coming onto the
balance sheet
Balance Sheet
Changes to whether or not a contract
contains a lease
Implied PP&E
Lessor has no practical reason or
right to substitute
Benefits of use of asset
+ Power to direct control of the asset
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Life Exceeds
75%Economic Life
NPV of Payments
>90%Fair Market Value
Transfer of
Ownership at
End of TermBPO
OR
Today Result
• 90%+ lease dollars are operating
• 95%+ lease records are operating
• Very few leases on balance sheet
CapitalFront Loaded
Expense
OperatingStraight-line
Expense
Balance Sheet
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Transfer of
Ownership at
End of TermBPO
OR
FinanceFront Loaded
Expense
OperatingStraight-line
Expense
Leases < 1 Year
Balance Sheet
Rental Expense
Specialized in
Nature+
Future
Life Exceeds
Economic Life
NPV of Payments
Fair Market Value
Major Portion Substantially All
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ASSET ACCOUNTING• Capital accounting for most leases• Depreciation forecasting• Transitioning leased assets to owned• Lease vs. buy decisions
TAX• Property tax responsibilities• Front loaded expense impacts
income taxes• Book/ tax differences• Potential for a 315 and 481a
adjustment for change in accounting
BUDGETING• Interest and amortization affects
O&M budgets• Capital approval processes
REGULATORY• Leases in rate base• Income statement treatment• Regulated assets and liabilities
LESS
EE A
CC
OU
NTI
NG
What are the Ripple Impacts
from Lessee Accounting?
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How to interpret removal of bright-line tests?• “Substantially all”• “Major Part”
Earnings impact?• Above the line vs. below the line• Capital leases included in EBITDA but have adverse EPS impacts at the start of the term
Will the IRS make any changes? • IRS still deliberating on future treatment• Monitor cutoff dates of leases to know if they are eligible for automatic changes in
accounting methods
Will FERC make changes?• Regulatory treatment is still up in the air• Will capital lease expense continue to follow payments? • Will regulatory assets / liabilities be required for FERC / GAAP differences?
Will State Commissions make changes?• How will states interpret FERC’s decisions when it comes time for rate cases?• Will more states include capital leases in rate base?
Lease vs. Buy decision criteria?
10
What Will Drive My Lease Adoption Strategy?
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Need not re-assess whether expired or existing contracts contain leases
Need not reassess capital vs. operating leases
Need not reassess initial direct costs incurred on lease contracts
Practical Expedients for Transition
11
• Scope out existing leases
Potential Lessee Benefits
• More or less capital leases
• Expense impacts
• EBITDA & EPS impacts
• Reduce capital leases dollars due
to internal costs
• Increase capital lease dollars and
front-loaded expense Non-lease components can be
included as lease costs by class of underlying asset
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LEASE ACCOUNTING LIFECYCLE
12
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Lease Initiation
Lease Sustainment
Reporting & Analysis
Termination & Renewal
Investment Ideation
Contract Management
Lease Process Flow
1313
IT
Real Estate
Fleet
Lease
Repository
WorkFlow
WorkFlow
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Lease Initiation
Lease Sustainment
Reporting & Analysis
Termination & Renewal
Investment Ideation
Contract Management
Lease Process Flow
IT
Real Estate
Fleet
Lease
Repository
WorkFlow
WorkFlow
Ideation
• Lease vs. Buy analysis
• Select lessor
• Negotiate lease terms
+ Assess potential capital
budget impacts
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Lease Initiation
Lease Sustainment
Reporting & Analysis
Termination & Renewal
Investment Ideation
Contract Management
Lease Process Flow
IT
Real Estate
Fleet
Lease
Repository
WorkFlow
WorkFlow
Contracts
• Store contracts in a
centralized repository
+ Check all contracts for
embedded leases
+ Route leases through
capital approvals in an
auditable system of
record
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Lease Initiation
Lease Sustainment
Reporting & Analysis
Termination & Renewal
Investment Ideation
Contract Management
Lease Process Flow
IT
Real Estate
Fleet
Lease
Repository
WorkFlow
WorkFlow
Initiation
+ Consolidate all leases for
reporting and
management
+ Determine capital lease
classification
+ Calculate schedules
+ Integrate with field leasing
systems
+ Automate balance sheet
additions
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Lease Initiation
Lease Sustainment
Reporting & Analysis
Termination & Renewal
Investment Ideation
Contract Management
Lease Process Flow
IT
Real Estate
Fleet
Lease
Repository
WorkFlow
WorkFlow
Sustainment
• Reconcile payments
to lessor invoices
• Calculate taxes
• Send payments to AP
+ Generate journals for
payments, expense,
principal and adjust
obligation
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Lease Initiation
Lease Sustainment
Reporting & Analysis
Termination & Renewal
Investment Ideation
Contract Management
Lease Process Flow
IT
Real Estate
Fleet
Lease
Repository
WorkFlow
WorkFlow
Reporting
• Future minimum
lease payments
+ Leasing standard
impact forecasting
+ Balance sheet
account balances
+ Capital lease vs.
operating lease
expense
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Lease Initiation
Lease Sustainment
Reporting & Analysis
Termination & Renewal
Investment Ideation
Contract Management
Lease Process Flow
IT
Real Estate
Fleet
Lease
Repository
WorkFlow
WorkFlow
Expire/Renew
Track bargain
purchase options and
renewals
+ Automate end of life
retirements
+ Manage early
terminations
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Example Lease Agreement
3 year lease – paid monthly in arrears• Year 1 - $500,000 per month
• Year 2 - $700,000 per month
• Year 3 - $1,000,000 per month
Fair market value of asset - $27,500,000
NPV of payments - $24,613,492
Capitalization percent = 89.50%
Current treatment – Operating Lease
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Year 1 Year 2 Year 3
Payment $6M $8.4M $12M
Straight Line $8.8M $8.8M $8.8M
Capital Expense $9.1M $8.8M $8.5M
Book / Tax
difference
$296K $43K ($339K)
Current Method - Operating
21
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-200000
0
200000
400000
600000
800000
1000000
1200000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
Current Treatment - Operating
22
Straight-lined
operating lease
expense
Expense if
recognized on basis
of payment
Book / Tax
Difference
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Capital/Finance Lease Future
23
Year 1 Year 2 Year 3
ROU Asset Balance $24.6M $24.6M $24.6M
Principal Payment $5.1M $7.8M $11.7M
Interest Expense $892K $639K $256K
SL Depreciation $8.2M $8.2M $8.2M
Total Expense $9.1M $8.8M $8.5M
FERC Depreciation $5.1M $7.8M $11.7M
Total FERC Expense $6M $8.4M $12M
Regulatory Difference $3.1M $443K ($3.5M)
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Future - Capital Lease
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-400000
-200000
0
200000
400000
600000
800000
1000000
1200000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
Total GAAP
Expense
Total FERC
Expense
Regulatory
Difference
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Future – Operating Lease
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Year 1 Year 2 Year 3
ROU Asset Balance $24.6M $24.6M $24.6M
Principal Payment $5.1M $7.8M $11.7M
Interest Expense $892K $639K $256K
SLE Depreciation $7.9M $8.2M $8.5M
Total Expense $8.8M $8.8M $8.8M
Book / Tax Difference
(if different treatment)
$296K $43K ($339K)
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-200000
0
200000
400000
600000
800000
1000000
1200000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
Future – Operating Lease
26
Total Expense
Straight-Line
Expense
Depreciation
Interest
Expense
Book / Tax
Difference
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PROPOSED ADOPTION TIMELINE
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Proposed Adoption Timeline
Consolidate Leases• Review existing contracts • Check AP for recurring payments• Reach out to operating units• Gather details for leasing standard
like renewal options, bargain purchase options, etc.
Change Management• How will you educate the organization on the new processes around entering into a lease agreement?
2 Year Lookback• You will need to report on leases in effect 2017
in 2019
Implement System• Automate Lease Accounting and Asset Creation• Guarantee Compliance• Automate Conversion of Operating Leases
Lease Standard Effective!
Forecast Balance and Income Sheet Impact• Balance Sheet – Assets, obligations, and depreciation coming onto balance sheet• Income Statement – P&L impacts of front loaded expense• Statements of Cash Flows – Cash flow from financing activities vs. operations
Assign Owner
Who will own leases going forward?
Capital Process Integration• How will the new leased assets be managed?• What will the capital approval process look like?• What system or tools will you be using to track leases and
their assets?• How will you add existing operating leases to the balance
sheet?
2016 2017 2018 2019
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Will Davis
Professional Services – Accounting Practice
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Key Takeaways
Accounting groups will be responsible for many more aspects of the leasing lifecycle
Keep in mind the ripple effects of lease changes on other areas
It is not too early to start preparing!
Reach out to PowerPlan if you have any questions
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