Tax Policy & Politics · • The new President will confront a Congress with sharp divisions and...

Tax Policy & Politics:A Glass Half Full or Half Empty?Storme Sixeas, Washington National Tax

Copyright © 2016 Deloitte Development LLC. All rights reserved. 2

$6.6 billion* later…* Estimated cost of 2016 federal campaigns, according to the Center for Responsive Politics


• Despite a clear electoral win, President-elect Trump seems to have a strong mandate for “change” but not necessarily for his agenda, especially since the campaign was light on policy

Election 2016: A few observations


One-third of Americans didn’t like their choices this yearA mandate for the President-elect?

Favorable view of Trump,Unfavorable view of Clinton

24%

Favorable view of Clinton,Unfavorable view of Trump

33%

Unfavorable view of bothClinton & Trump

35%

Favorable view of both Clinton & Trump

2%No opinion

6%Source: Monmouth University Poll, Aug. 25-28, 2016



• The new President will confront a Congress with sharp divisions and its own agenda(s) and political dynamics

• Incoming Senate Democratic Leader Chuck Schumer is more open to tax reform than outgoing leader Harry Reid. However, Schumer faces a daunting map for 2018 and a potentially expanding rift between the progressive and more moderate members of his caucus



The Senate Story - 2016

Light color = retirement/open seat


2016: A good map (on paper) for Democrats; 2018: A very different story

Senate Seats Contested In 2016 Senate Seats To Be Contested in 2018



• The new President will confront a Congress with sharp divisions and its own agenda(s) and political dynamics

• Expected incoming Senate Democratic Leader Chuck Schumer is more open to tax reform than outgoing Democratic leader Harry Reid. However, Schumer faces a daunting map for 2018 and a potentially expanding rift between the progressive and more moderate members of his caucus

• In the House, Republicans saw the size of their majority reduced slightly, from 246-186 to 238-194 (with 3 races outstanding)

‒ This governing challenge will be made greater because almost none of the members leaving Congress at the end of this session are from the cohort typically reluctant to follow leadership’s chosen strategy



Who is returning to the House GOP next year?The math won’t get easier

Note: The 2015 votes included Omnibus spending, Tax extenders, Long-term highway bill, Ryan for Speaker, Debt ceiling, Continuing Resolution (9/30), Trade Promotion Authority, Budget Resolution, Doc Fix, Short-term DHS fundingSource: Voting data compiled by Bruce Mehlman, Mehlman Castagnetti, and Deloitte Tax LLP

136

94

14

118

80

13

Loyalists (8-10 YES votes) Maybes (4-7 YES votes) Reluctants (0-3 YES votes)

2015 2017

Plus at least 26 new GOP Members whose voting patterns will take time to come into focus


Setting the stage for 2017: The big picture


Red ink falling but for how long?

0

2

4

6

8

10

12%

of G

DP

Budget Deficits as a Share of GDP

Source: Congressional Budget Office, Updated Budget Projections: 2016 to 2026 (Mar. 2016), The 2016 Long-Term Budget Outlook (Jul. 2016)

50-year average (1966-2015)2.8%



0

2

4

6

8

10

12%

of G

DP



50-year average (1966-2015)2.8%



0

2

4

6

8

10

12%

of G

DP



50-year average (1966-2015)2.8%


Automatic spending has taken over the budget

Source: Congressional Budget Office (CBO)

34%

66%

1965

68%

32%

2015

78%

22%

2026 (projected)

Mandatory spending+ net interest

Discretionary spending


How much revenue should the government raise?

Note: “Revenue baseline” assumes current laws remain unchanged (e.g., expiring tax cuts lapse as scheduled). Senate Democrats’ figures represent the CBO baseline adjusted upward by the annual revenue increases proposed in the Senate Democrats’ FY2014 budget (proposed increase was $923 billion relative to then-current law).Source: Congressional Budget Office (CBO) publications Updated Budget Projections: 2015 to 2025 (August 2015) and Updated Budget Projections: 2016 to 2026 (March 2016)

17.6

17.8

18.0

18.2

18.4

18.6

18.8

19.0

19.2

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

% o

f G

DP

Revenue Baseline Projections

CBO Revenue Baseline - August 2015Senate Democrats' Revenue BaselineCBO Revenue Baseline - March 2016


More than just “closing loopholes”Broadening the base

Source: Joint Committee on Taxation publication JCX-141R-15, “Estimates Of Federal Tax Expenditures For Fiscal Years 2015-2019,” Dec. 7, 2015.

Largest Corporate Tax Expenditures – 2015 $ Billion

Deferral of active CFC income 99.3

§199 deduction 11.7

Deferral on like-kind exchanges 11.0

Exclusion for muni bond interest 9.7

Low-income housing tax credit 7.3

Deferral of gain on installment sales 6.9

§179 expensing 4.8

Expensing of R&D expenditures 4.7

Reduced tax on corporate income below $10M 4.0

Special treatment of life insurance co. reserves 2.9

Accelerated depreciation -20.0*

Largest Individual Tax Expenditures – 2015 $ Billion

Tax-preferred retirement plans 157.4

Exclusion of employer-provided health benefits 145.5

Reduced rates on LT cap gains/dividends 131.7

Earned Income Tax Credit 72.7

Mortgage interest deduction 71.0

State and local tax deduction 62.2

Child tax credit 57.1

Charitable contribution deduction 45.6

Exclusion of Social Security benefits 37.6

Property taxes deduction 32.4

Exclusion of cap gains at death 32.4*Accelerated depreciation is a negative expenditure (brings in revenue) in the short term but a revenue loss in the longer term.

https://www.jct.gov/publications.html?func=startdown&id=4858


Setting the stage for 2017: Summarizing the Trump Tax Plan


Business taxesTrump tax plan

Corporate Rate 15%

Pass-through Rate 15%, but unclear to which entities and income it applies/other restrictions

Corporate AMT Eliminate

Full ExpensingUS manufacturers may elect full expensing or interest deductibility; election irrevocable after 3 yearsInterest

Deduction

International• No changes currently specified to current regime (2015 plan called for retaining

current-law worldwide regime and foreign tax credit but repealing deferral)

• Deemed repatriation at 10% tax rate


Business taxesTrump tax plan

Financial Products & Institutions Phase out deferral of inside build-up on life insurance contracts for high earners

Energy No change specified, but has called for repeal of most business tax expenditures except R&D credit

Employer-Provided Childcare

• Increase credit cap to $500k

• Shorten recapture period to 5 years

Other• Repeal Affordable Care Act and all related taxes

• Eliminate most business tax expenditures except R&D credit


Individual taxesTrump tax plan

Individual Rate• New brackets: 12% on <$75k; 25% on $75k-225k; 33% top rate on >$225k

• Eliminate 3.8% net investment income tax

Capital Gains /Dividends 0% on <$75k; 15% on $75k-225k; 20% top rate on >$225k

Carried Interest Tax as ordinary income

AMT Eliminate

Deductions

• Standard deduction $15k/$30k

• Cap itemized deductions at $200k/$100k

• Eliminate personal exemptions and head of household


Individual taxesTrump tax plan

Estate & Gift Tax

• Eliminate, but capital gains held until death subject to tax, with first $10m tax-free (unclear whether this is per person or per couple)

• Disallow “contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives”

New Tax Benefits

• Deduction for childcare (avg. state cost) and eldercare (inflation-adjusted $5k cap), for those with income <$500k/$250k

• Refundable childcare credit for EITC recipients

• Dependent Care Savings Accounts with 50% govt match for low-income families


Revenue estimatesTrump tax plan

Tax Policy CenterStatic estimate • 10-year revenue effect = -$6.2 trillion

Tax Policy CenterDynamic estimate

• 10-year revenue effect = -$6 trillion• 10-year GDP impact = -0.5%

Tax FoundationStatic estimate* • 10-year revenue effect = -$4.4 trillion to -$5.9 trillion

Tax FoundationDynamic estimate*

• 10-year revenue effect = -$2.6 trillion to -$3.9 trillion• 10-year GDP impact = +6.9% to +8.2%

Most impactful provisions:• Corporate rate reduction• Individual rate reduction• Repeal of net investment income tax

* Ranges provided because of uncertainty about application of pass-through tax rate


Congress will also want to be heard on tax policy…

And it won’t be with one voice


House Republicans

Senate Republicans

Obama Administration

House Democrats

Senate Democrats


Continued focus on tax reform for growthHouse Republicans

• House Republicans released a tax reform “blueprint” on June 24, showing where they want to take the debate

• Primary focus: policies designed to create economic growth‒ At every juncture, when forced to choose between two options, the answer is “whichever the

economists believe will boost GDP most”‒ Poses interesting trade-offs, most notably by moving to full expensing while repealing the

deduction for net business interest expense (shifting towards a consumption-based system)

• Stated goal to be revenue neutral relative to the current policy baseline and when scored dynamically, but outside estimates vary greatly and require many assumptions due to lack of legislative text‒ Tax Foundation: $191 billion/10-year cost, with GDP 9.1% higher over the same period‒ Tax Policy Center: $2.1 trillion to $3 trillion/10-year cost, with change in GDP of 1% or less

• With Republicans also controlling the White House and Senate next year, House Republicans can be expected to press hard for tax reform


Why the House GOP is focused on “growth”

Source: POLITICO Caucus November 2015 survey of a bipartisan group of influential political strategists, operatives and activists in Iowa, New Hampshire, South Carolina and Nevada

Democrats

Economic growth 17%

Unemployment 2%

Republicans

Taxes 10%

Deficit reduction

23%

Unemployment 2%

Economic growth 65%

Economic inequality

81%

What is the most important economic issue driving the 2016 presidential campaign?

http://www.politico.com/story/2015/11/insiders-economy-caucus-215931%23ixzz3rxagrJ28


Blueprint summaryHouse Republicans

Business Tax

• 20% corporate tax rate; 25% rate on pass-through business income

• 100% expensing (rather than depreciation); repeal deductibility of business interest

• Repeal corporate AMT

• R&D credit and LIFO retained; most other business tax credits and deductions assumed to be repealed

International Tax

• Full territorial system (no tax on repatriation of future foreign profits)

• Transition rule that has a deemed repatriation of past foreign profits (8.75% rate on cash and cash equivalents; 3.5% rate on everything else; payable over eight years)

• Border adjustable, which the blueprint says will obviate the need for most base erosion safeguards


Blueprint summaryHouse Republicans

Individual Tax

• Reduce seven tax brackets down to three – 33%, 25%, and 12%

• 50% exclusion for investment income (capital gains, dividends, interest)

• Combine and expand the standard deduction and personal exemption, allowing fewer taxpayers to go through the complexity of itemizing

• Retain, though possibly in a modified form, the deductions for mortgage interest and charitable contributions as well as incentives for savings and education

• Repeal most other individual income tax preferences, including for state and local taxes

• Repeal AMT

• Repeal estate and gift tax


Focused more on “flaws” in the tax codeHouse Democrats

• Some Ways & Means Democrats seem interested in tax reform and have led the way on discrete parts (e.g., Rep. Richie Neal pairing with GOP Rep. Charles Boustany in 2015 to unveil an innovation box)

• However, the general approach of Ways & Means Committee Democrats is to continue to push for action to address what they say are deep flaws in the tax code, including:

‒ Treatment of carried interest

‒ Inversions and tax benefits available for formerly U.S.-domiciled firms

‒ Fossil fuel incentives

• As the minority party in the House, they have an important role to play in drawing contrasts with the majority but rarely see their ideas enacted into law

• They are unlikely to be helpful in supporting the sort of tax reform that Trump and House Republicans will likely pursue


A different type of tax reform?Senate Republicans

• Senate Finance Committee Chairman Hatch has been working on “corporate integration” proposal all year‒ Generally expected that it would give corporations a deduction for dividends paid while

requiring all dividend recipients to pay tax on them at ordinary income rates‒ Recipients subject to full tax (i.e., not at preferred rates) would include not just taxable

shareholders but also foreign investors and those individuals who hold stocks in retirement accounts, charities, and pension funds

‒ To avoid favoring debt over equity, the proposal is also expected to impose a similar tax regime on recipients of interest payments on corporate bonds

‒ Prospects for any action are unclear; Chairman Hatch has so far delayed releasing it but may still do so this year

• In 2017, Senate Republicans may find themselves pivoting back toward a more traditional and comprehensive approach to tax reform


Hopes of the majority dashedSenate Democrats

• Like his House counterparts, Senate Finance Committee Ranking Member Ron Wyden has urged Congress to act in the short term on the issue of inversions

• Unlike his House counterparts, he has also worked on a broader vision of tax reform, unveiling two (with Republican co-sponsors) in previous years when he was just a “back-bencher” on the panel

• This year, he has released discussion drafts on three pieces of tax reform as a way to “be in position” in case Clinton won and made tax reform a priority‒ Streamlining depreciation‒ Simplification of financial products taxation ‒ Reforming rules for retirement savings accounts

• Incentives for Senate Democrats to push for tax reform are unclear under a Trump presidency, but there may be areas of agreement on which legislation can be built


Could 2017 be the year for tax reform?

It depends…


Will 2017 be the year for tax reform?

• It is hard to view this campaign as having been a public affirmation of anything related to tax policy and certainly not corporate tax reform.

• Trump and Speaker Ryan may not start out on the best of terms.

• Working collaboratively with the new President might be politically difficult for Democratic members, whose constituents have expressed a strong dislike for Trump.

• Trump could use his “honeymoon” period to advance a key issue such as tax reform.

• President Obama and congressional Republicans got off on a bad foot in 2009, and things only got worse from there. As a newcomer to elected office, Trump has the opportunity for a “fresh start” with Congress.



• Tax reform needs strong presidential focus. President Obama did not provide it and, to this point, it is not entirely clear where this falls on the list of the President-elect’s priorities.

• Senate Democrats are likely to face substantial internal disagreements about whether – and in what way – to help advance the ball on tax reform.

• Leaders in Congress (House Speaker Ryan and incoming Senate Democratic Leader Schumer) are more interested in tax reform than those who held similar positions in 2013-2014, when then-Finance Committee Chairman Max Baucus and Ways & Means Committee Chairman Dave Camp made a run at reform.



• Under current rules, tax reform enacted via reconciliation cannot lose revenue after the first decade, and that does not square with what we expect Republicans to push. This means they will have to either temper their expectations or work towards temporary tax reform, a prospect that could cause otherwise supportive stakeholders to balk.

• Other procedural barriers under reconciliation (prohibitions on extraneous provisions that don’t have substantial revenue implications, etc.) may impede passage.

• Republican-only tax reform comes with substantial political/policy challenges; internal disagreements could keep them from “getting to yes.”

• With Trump in the White House and Republicans retaining control of the House and Senate, the GOP is firmly in control, in general agreement on the need for tax reform, and could use their clean sweep to push it via reconciliation.



• Deemed repatriation by itself is not tax reform and many fear it could sap momentum for broader reform.

• It is an open question as to whether Republicans would even go for such a package, which looks a lot like “tax and spend.”

• A shared interest in boosting the economy could lead lawmakers to support an infrastructure spending plan, and deemed repatriation is a potential funding source.



• Tax reform is always easier said than done. The actual task of paring back popular credits and deductions offers ample opportunities for well-organized opposition to arise.

• Not all Senate Democrats are on board. Progressive Senators Elizabeth Warren and Bernie Sanders oppose corporate rate cuts generally, and top Finance Committee Democrat Ron Wyden has once again embraced his support for repealing deferral.

• It is politically easier to demagogue “bad actors” than to develop solutions that can be portrayed as benefiting companies that shift jobs overseas.

• There is growing bipartisan agreement in Congress on the need for tax reform. Even House Minority Leader Nancy Pelosi said in September that the US needs a lower corporate tax rate that produces growth.

• Inversions, foreign acquisitions, state aid cases, and BEPS make action on tax reform more politically urgent than ever.



• We can’t ignore the risk of a “black swan” event.

• A closely divided Congress may be more conducive to continued gridlock.

• The 2018 mid-term elections are about 710 days away, followed closely by the 2020 Presidential election in about 1435 days.

• The economy appears to be solid, if unexceptional, allowing Congress space to work on big but difficult issues.


Questions?


Appendix


• President submits budget by first Monday in February

• House and Senate Budget Committees report budgets by April 1

• Full House and Senate agree on a concurrent budget resolution by April 15 ‒ Establishes a spending ceiling and revenue floor that are designed to constrain the budget

impact of subsequent legislation ‒ Covers both mandatory (Medicare, Social Security, etc.) and discretionary (defense,

education, etc.) spending‒ Can be used to make “reconciliation” bills in order – valuable to the majority party, because

they are not subject to filibuster in the Senate

• House and Senate Appropriations Committees use budget to draft 12 appropriations bills, which Congress passes and the President signs by October 1‒ Divvies up the budget into specific spending categories and line items by agency

The budget process: in theory

1APRIL

15OCTOBER


• The President is often late in his budget submission to Congress, especially in the first year of an Administration ‒ Last year’s was the first on time since 2010; this year’s was submitted Feb. 9 (8 days late)‒ Clinton’s first budget submission: April 8, 1993; G.W. Bush’s: April 9, 2001; Obama’s: May

7, 2009

• Congress rarely adopts a concurrent resolution on the budget by April 15, if at all‒ Last year’s resolution (adopted May 5, 2015) was the first since 2009

• Budget points of order are often waived ‒ In the Senate, waiver requires 3/5 vote; in the House, a simple majority will usually suffice

• Discretionary accounts are often funded through continuing resolutions, not appropriations bills‒ All 12 appropriations bills were last enacted on time in 1996 (for FY97) ‒ Since 2010, 29 continuing resolutions have been needed to keep the government open

• A separate debt limit constrains overall federal borrowing and must be raised or waived from time to time

The budget process: in practice


How does it work?GOP control raises prospects of “budget reconciliation”

• House and Senate must agree on a budget resolution that includes reconciliation instructions

• Reconciliation instructions cannot be prescriptive – they may specify only:‒ The Committee(s) charged with reporting legislation‒ The budget impact of legislation to be reported ‒ Date by which Committee(s) must report conforming legislation

• Maximum of 3 reconciliation bills can be moved in a year – one each for revenues, spending, and debt limit

• Limited debate – legislation moved under reconciliation cannot be filibustered in the Senate

• The “Byrd Rule” can set up 60-vote hurdles in the Senate, including with respect to:‒ Provisions which have no budgetary effect or whose budget effect is “merely incidental”‒ Provisions which would increase the deficit in any year beyond the period covered by the

budget (recall the expiring 2001/2003 tax cuts)

• Recent uses: 1996 welfare reform, 2001 tax cuts, 2003 tax cuts, 2010 health care reform law


Storme SixeasSpeaker bio

Storme Sixeas is a member of the Tax Policy Group within the Washington National Tax practice of Deloitte Tax LLP. Drawing on her extensive experience in the policy arena, she identifies, evaluates, and monitors legislative proposals, and interprets the practical issues surrounding the application of tax proposals. Storme provides political intelligence based on ongoing interaction with Congressional members and staff and helps Deloitte’s clients stay on top of the numerous and often complicated debates in tax policy.

Prior to joining Deloitte in 2015, Storme spent a dozen years as a corporate policy lobbyist, covering issues including corporate tax, trade, federal contracting, technology policy, and intellectual property. During that time, she was the chief policy lobbyist for defense company BAE Systems, Inc., and for the Electronic Industries Alliance (EIA), a high-tech trade association; and she represented clients in the technology and defense industries as a consultant. Previously, Storme served as a House of Representatives leadership aide on Capitol Hill.

Before entering the legislative and policy arenas, Storme spent several years in financial and technology journalism, working in various reporting and editing capacities at organizations including the Financial Times Group in London.

After growing up around the globe as an Air Force brat, Storme earned a Bachelor of Journalism from the University of Missouri-Columbia. She also holds an MBA in financial management from George Mason University.

Phone +1 202-220-2078Email [email protected]

mailto:[email protected]


This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.

Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.

Disclaimer

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Economic Outlook in a time of transitionPatricia BuckleyNovember 2016

Copyright © 2016 Deloitte Services LP 2

These three trends continue to shape the outlook…so how will the new policies interact with these trends?

High value of the US dollar

Slower GrowthLow oil prices

OIL


Low oil prices create many winners and losers: consumers and business users (for production and feedstock) gain, while oil producers and their suppliers lose

$ per barrel (WTI)

Source: Energy Information Agency and FRED Graph


The rising value of the dollar challenges US exporters, but helps US consumers and countries that import to the US

Trade-weighted value of the $

Source: Federal Reserve Board of Governors and FRED Graph


World growth is slowing…

Annual Percent Change in World GDP Growth

Source: International Monetary Fund, World Economic Outlook


Led by a slower growing China

Percent Change in China's Real GDP Year over Year


Recovering from the recession has been tough

Change in Real GDP - Q1 2008 = 100

Source: Eurostat, ONS and BEA


Japan faces structural issues

Source: US Census Bureau

0

10

20

30

40

50

60

70

80

90

2000 2010 2020 2030 2040 2050

Retiree Dependency Ratio Population 65 and above as a percent of 100 Population 15-64

Japan

Germany

China

US


Eurozone is in its 3rd year of recovery and some of its most troubled economies are improving

The Eurozone as a whole grew by 1.6% in 2015, improvement over the 0.9% GDP growth in 2014.

GDP growth, 2015

Source: European Commission

6.0

3.2 3.12.0 1.7

1.1 0.9

-1.4-2-101234567


Issues remain for the Eurozone

Source: Eurostat


Issues remain for the Eurozone

Source: Eurostat


Forces shaping US growth

Contributions to percent change in GDP


Individuals are doing better…on average

Household Net Worth

Unemployment RateReal Disposable Income per Capita

Source: Federal Reserve Bank of St. Louis FRED Charts using data from Bureau of Economic Analysis and Bureau of Labor Statistics


So what is the debate surrounding the unemployment rate?

U4 versus U6


So what is the debate surrounding the unemployment rate?

U4 versus U6


Not all sectors are gaining to the same extent

Employment change by selected industry


Rise in real consumption is partially attributable to lower prices of oil and imports, but also to increased employment…

…but will strong employment growth continue this year?

?

Source: Bureau of Labor Statistics

Change in thousands


Some business indicators slowing even as stocks remain highCorporate Profits After tax with inventory and capital consumption adjustments

Manufacturing Industrial Production

Source: Federal Reserve Bank of St. Louis FRED Charts using data from Bureau of Economic Analysis and Federal Reserve Board

S&P 500


Exports will continue to be a weak component

Source: Bureau of Economic Analysis

Exports contribution to GDP growth

3.21.6 2.0 2.6 2.9 2.7

1.80.8

-1.0 -0.71.2 0.7

1.7 1.11.9 2.3

0.9

-0.6 -0.2

0.20.9 0.6

0.91.0

0.7

-1.1

1.30.9

0.50.4

0.5 0.2

-3-2-1012345

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

GDP minus exports Exports

Perc

enta

ge

0.85 pp 0.4 pp 0.2 pp


Additional factors that will shape the near term

• Slow productivity growth

• How will Brexit play out?

Copyright © 2015 Deloitte Development LLC. All rights reserved.

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Where will tomorrow’s growth come from?


Slow population growth will limit economic growth going forward

Growth in the US working age population

0.2

0.4

0.6

0.8

1.0

1.2

1.4

2005 2010 2015 2020 2025 2030

US working age population growth ratePercent

Source: Census/Haver Analytics

2001-2015 average=.9

2016-2030 average = .3


So growth will depend on a pickup in productivity

-1

0

1

2

3

4

5

6

96 98 00 02 04 06 08 10 12 14

1995-2003 average = 2.9

2004-2015 average = 1.5

Source: BLS/Haver Analytics

Output per hour, business sector. Percent change, year ago


The distribution of income remains an issue--A larger share of total income is going to the top of the distribution

• Income inequality is rising—by a lot.

• The top 10% took about 1/3 of all income from the end of WW2 to the 1980s.

• The top 10% now take about half of all income.

• Notice the rise of about 16 percentage points

28

32

36

40

44

48

20 30 40 50 60 70 80 90 00 10

Share of total income earned by peoplein the top 10% of the income distribution

Source: The world wealth and income database


And the top 1% is doing even better.

• Notice the rise of about 10%. More than half of the rise in the top 10% share (16%) was due to the rise of the top 1% share!

• The top 1% takes almost 1/5 of all national income.

• Maybe it’s not surprising that some people are calling this “the new gilded age.”6

8

10

12

14

16

18

20

20 30 40 50 60 70 80 90 00 10

Share of total income earned by people in the top 1% of the income distribution

Source: The world wealth and income database

And what about Brexit?


Snapshot of Britain's uneven relationship with “Europe”

• The UK didn’t join the original EEC.

• Then when it tried to join in early 1960s, Charles De Gaulle said “Non”.

• The UK finally joined in 1973.

• Then came the 1975 referendum. It was the first referendum in UK history, with 67% voting to remain in the EEC.

• The long saga of the UK’s contribution to EEC budgets resulted with a Margaret Thatcher victory—and special status for the UK.

• The UK stayed out of the Schengen agreement in 1990 and the common currency in 1992-2000. That required special agreements, especially for London’s financial sector.


1•National authorities notify the EU they want to leave. PM Theresa May recently announced that Article 50 will be invoked before the end of March.

2• A two year clock starts. The country’s authorities

negotiate the new relationship with the EU authorities.

3• Either an agreement is reached on a new relationship

or…when time is up, the country’s relationship becomes “generic,” i.e., reverts to WTO rules, where the EU gives NO special concessions to the former member.

Process to leave the EU – Article 50


Some trade arithmetic

Source: BEA and Deloitte calculations

The above calculations suggest that the direct impact of the slowdown in Europe on the United States will likely be limited.

USD Billions % of GDP

US GDP (2015) 17,947

US exports (2015) 2,253 12.5

US exports to the UK (2015) 123 0.7

US exports to the rest of the EU (2015) 377 2.1


Expected future outcome

45

1Unless there is a financial markets crisis, the short-term impact of Brexit on the US (and even on Europe) will likely be minimal.

2 Slower investment and higher trade barriers will likely slow growth in the medium to long run in the UK and the Eurozone.

3 The medium-long run impact on the US will likely be small.

Despite the expected minimal impact, the US did not need another economic headwind.


We continue to forecast moderate growth, but what are some things that could cause a change in outlook?

•Hard landing for China

•Fed makes a mistake—on either side

•Brexit gone bad

•Banking crisis from Europe

Copyright © 2015 Deloitte Development LLC. All rights reserved.



This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.

As used in this document, “Deloitte” means Deloitte LLP and its subsidiaries. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting.

Copyright © 2016 Deloitte Development LLC. All rights reserved.36 USC 220506


SEC ServicesSEC UpdateNovember 29, 2016

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CommissionerStein

22 other offices

Corporation Finance

Keith Higgins

Economic and Risk Analysis Enforcement

Industry AD Group

10 other AD groups

Corp Fin—Office of the Chief Accountant

Mark Kronforst

Source: Information from www.sec.gov/corpfin/Article/filing-review-process---corp-fin.html

Chair WhiteOpenOpen

*Lisa Fairfax and Hester Peirce nominated for open seats by President Obama, subject to Senate confirmation

SEC organizational structure


Enforcement initiatives

• Financial Reporting and Audit (“FRAud”) Task Force−Continued to prioritize issuer reporting and disclosure matters in FY 2016 −Monitors restatement activities and audit failures −Uses technology and tools for “data mining” and data analysis

• Other policy-related initiatives−Admission of wrong-doing−Focus on the individual

• Whistleblower Program−Awarded $111 million to 34 whistleblowers since inception−Retaliation and “pre-taliation” concerns

FY 2016 FY 2015 FY 2014

Number of enforcement actions 868 807 755

Orders for penalties & disgorgements (approx.) $4.0 billion $4.19 billion $4.16 billion


SEC environment and rulemaking

Dodd-Frank Act

JOBS Act

FAST Act

Non-GAAP Measures - Updated Compliance & Disclosure Interpretations (C&Dis)

Disclosure Effectiveness

Resource Extractors Disclosures –Final Rule

Small Reporting Company Definition -Amendment



What is it?

• Providing better information to investors – more understandable, more useful and eliminating excessive disclosure

• Could result in additional disclosures

What has the SEC staff done lately?

• Request for comment on financial disclosures about entities other than the registrant – comment period closed November 30, 2015

• S-K concept release – comments closed July 21, 2016

• Disclosure Update and Simplification proposed rule – issued July 13, 2016, comment period closed Nov 2, 2016

1

2

3 Focus on material and relevant matters

Reduce or eliminate redundant disclosures

Tailor disclosures to company’s facts and circumstances



Background on Regulation S-K and the Release

What’s in?

• The overall disclosure framework

• Disclosures for investment and voting decisions –

Specific business and financial disclosure requirements in Regulation S-K

1

2

3

Focus on material and relevant matters


• Core company business information • Public policy and sustainability matters

• Company performance, financial information, and future prospects • Exhibits

• Risk and risk management • Scaled requirements

• Securities of the registrant • Frequency of interim reporting

• Industry guides • Presentation and delivery

Regulation S-K Concept Release



What’s out?

Public-company disclosure issues that are not a focus of the release

SEC encouraged comments on any disclosure topic

1 Focus on material and relevant matters


• Proxy Info – Compensation and governance information

• Modernization of the EDGAR system

• Non-GAAP measures • Disclosures required for foreign private issuers

• Inline XBRL • Business development companies

These topics may be considered in future stages of the SEC’s disclosure effectiveness project

Regulation S-K Concept Release



Category of proposed change Goal of proposed change

Example topic(s) affected (see proposal for specified changes)

Redundant or duplicative requirements

Eliminate requirements that result in substantially the same information under SEC rules, US GAAP or IFRS

FXConsolidationsDebt obligations

Overlappingrequirements*

Eliminate requirements that result in reasonably similar information or information that may no longer be useful to investors

ConsolidationsSegments

Outdated requirements Amend requirements that are obsolete Market price disclosures

Superseded requirements

Amend requirements that are inconsistent with new requirements Extraordinary items

1

2

Focus on material and relevant matters


Tailor disclosures to company’s facts and

circumstances

Disclosure Update and Simplification proposed rule


Consider for 2016 10-K:

• Additional qualitative disclosure if impact cannot be reasonably estimated:

−The effect of any accounting policies you expect to select upon adopting the ASU(s)

−How such policies may differ from the your current accounting policies

−The status of the implementation process and the nature of any significant implementation matters that have not yet been addressed

Revised financial statements in registration statements

“Investors should expect the level of disclosures to increase as companies make further progress in their implementation plans” in connection with newly issued standards.—

Wesley Bricker, Interim Chief Accountant, Office of the Chief Accountant

Newly issued accounting standardsSAB Topic 11.M (SAB 74) disclosures on new revenue, lease and credit loss accounting standards


Non-GAAP measuresEvolution of non-GAAP measure rules and regulations

2001

2003

2010

2015

2016

SEC issues “cautionary advice” to registrants

SEC issues Regulation G and S-K Item 10(e)

Compliance & Disclosure Interpretations (C&DI’s) issued by SEC

SEC increases focus on non-GAAP measures as measures increase in use and prominence

New and updated C&DIs issued by SEC


Updated compliance and disclosure interpretationsNon-GAAP measures

• More prominent presentation of non-GAAP measures (C&DI 102.10)

−Full non-GAAP income statement

−Omitting comparable GAAP measures from press release headlines

−Bolder or larger font

−Non-GAAP measure that precedes a comparable GAAP measure

−Equally prominent description for a GAAP measure (e.g. “record performance”)

−Disclosures related to forward looking non-GAAP measures

−Same discussion and prominence for GAAP measures

−Tabular disclosure/reconciliation that starts with a non-GAAP measure

“Non-GAAP measures are intended to supplement …and not supplant the information in the financial statements.”-Jim Schnurr, Chief Accountant, Office of the Chief Accountant


Updated compliance and disclosure interpretations and current thinking

Non-GAAP measures

Misleading measures (C&DI 100.01–100.04)• Financial measures using individually tailored accounting principles (C&DI 100.4)

−Using a registrants' own set of accounting principles to determine a non-GAAP measure

−Staff will not object to a measure that adjusts to reflect the adoption of the new revenue recognition accounting standard

• Prohibition on presenting liquidity measures on a per share basis (C&DI 102.05)

−Designated performance measures that are really liquidity measures

• Non-GAAP tax expense (C&DI 102.11)

−Tax adjustments commensurate with the non-GAAP measure of profitability

−Clear explanation of how the adjustment was determined

• Challenge non-GAAP adjustments

−Restructuring and litigation


Non-GAAP measures – What to ask?

1. Is the measure misleading or prohibited?

2. Is the measure presented with the most directly comparable GAAP measure and with no greater prominence than the GAAP measure?

3. Is the measure appropriately defined and described, and clearly labeled as non-GAAP?

4. Does the reconciliation between the GAAP and non-GAAP measure clearly label and describe the nature of each adjustment, and is each adjustment appropriate?

6. Is there transparent and company-specific disclosure of the reason(s) why the measure is useful for investors and the purpose for which management uses the measure?

7. Is the measure balanced (i.e., it adjusts not only for nonrecurring expenses but also for nonrecurring gains) and consistently prepared?

8. Does the measure appropriately focus on material adjustments and not include immaterial adjustments that would not seem to be a focus of management?

9. Do the disclosure controls and procedures address non-GAAP measures?

10. Is the audit committee involved in the oversight of the preparation and use of non-GAAP measures?

Non-GAAP measures


Roadmap to Non-GAAP Financial Measures

• Devoted to non-GAAPS

• Assess appropriateness of non-GAAP measures

• Combines SEC guidance with interpretations and examples

• Appendixes also includes

−Questions to ask when disclosing non-GAAPs

−Highlights and remarks from recent SEC officials

−Example comments on non-GAAPS


Filing Reviews

• About 9,000 registrants

• Focus on 2,500 registrants that comprise 98% of market cap

• All issuers reviewed at least 1 out of every 3 years

• No more Tandy language

• Staff is listening to analyst/earnings calls, reviewing press releases, Web sites, social media, and issuing comments

• Comments are posted to EDGAR 20 days after completion of review

* Source: The data presented in the chart were obtained from the SEC’s FY 2015 Annual Performance Report and FY 2017 Annual Performance Plan. Further, the SEC’s fiscal year ends on September 30.

SEC review process


Review processSEC review process

Reviews With Comment Letters and Number of Comment Letters Trending Downward

2,171 2,1031,770

1,476

998

3,6473,329

2,803

2,212

1,485

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2012 2013 2014 2015 2016

Reviews with Comment Letters Number of Comment Letters

Linear (Reviews with Comment Letters) Linear (Number of Comment Letters)

Source: Information in the table is derived from data provided by Audit Analytics, includes comments related to Forms 10-K and 10-Q, as well as related amendments, for reviews that have been “closed.” Current and prior year information includes comments for the 12-month periods ended July 31, 2016 and 2015, respectively.


Deloitte comment letter seriesSEC comment letter trends and statistics

• Ninth Edition — October 2015

• Insights into areas the SEC staff has focused on in recent comment letters including:

− Financial Statement Accounting and Disclosure Topics

− SEC Disclosure Topics

− Disclosure Topics in Initial Public Offerings

− Industry-Specific Topics

• Consumer & Industrial Products

• Energy & Resources

• Financial Services

• Health Sciences

• Technology & Telecommunications

• Supplement issued October 2016 provides updated analysis, which includes:‒ Update of SEC’s strategic priorities

‒ Updated top-10 list of most common trends

‒ Expanded presentation of comment letter statistics

‒ New trends in business combinations, leases and pensions



Top 10 Topics in ReviewsSEC comment letter trends and statistics



SEC comment letter trends and statisticsComment Letters per Review



SEC comment letter trends and statisticsDays to Complete a Review



SEC comment letter trends and statisticsObservations About Reviews by Filing Status


Areas of FocusSEC comment letter trends

Non-GAAP Measures Transparency & Consistency

Can’t be used in misleading way

Recent press and SEC focus

MetricsClearly define metrics and explain how calculated

Explain how used by management and why important to investors

Describe how a metric is related to current or future results of operations


SEC comment letter trends

Revenue Recognition

• Gross vs Net

• Multiple element arrangements

• Contra-revenue items

• New revenue standard

− SAB 74 disclosures

− Full retrospective adoption and registration statement

− Prospectus supplements not fundamental change

Areas of Focus



Income Taxes

• Valuation Allowance

• Rate reconciliation

− Appropriate breakout (and descriptions of) adjustments

• Impact of foreign operations

• Repatriation of foreign cash

Areas of Focus



Segments

• SEC staff’s focus is evolving:

− Chief Operating Decision Maker (CODM) package- no longer determinative

− Staff will consider total mix of information

• Aggregation of operating segments still a focus - consider both quantitative and qualitative factors

• Consider whether CODM is someone other than CEO

• Both SEC and PCAOB are focusing on segments

Areas of Focus



Business Combinations

• Purchase price allocation

• Determination of fair values and key assumptions

• Determining the accounting acquirer (NEW TREND)

Goodwill and Intangibles Impairment

• Valuation Assumptions and sensitivity (FRM 9510)

• Specific events that caused the impairment – “why now”

• Early warning disclosures

Areas of Focus



Immaterial restatements and ICFR

• Material weaknesses typically identified in conjunction with a material restatement or audit adjustment

• Impact of immaterial restatements on ICFR

− The “could” factor

◦ Not limited to the size of the error identified

◦ Level of deficiency should be based on potential error

− Must disclose material changes in ICFR

• Significant focus of SEC and PCAOB

Areas of Focus



Leases

• Build-to-suit transactions (NEW TREND)

Pensions and other post retirement benefits

• Alternatives to applying discount rates for defined benefit plans (NEW TREND)

Areas of Focus



• Disclosures on Newly Issued Standards (SAB 74) and related implementation issues

• Consider for revenue, leases, and credit impairment, among others

• Additional qualitative disclosure if impact cannot be reasonably estimated:

− The effect of any accounting policies you expect to select upon adopting the ASU(s)

− How such policies may differ from the your current accounting policies

− The status of the implementation process and the nature of any significant implementation matters that have not yet been addressed

“Investors should expect the level of disclosures to increase as companies make further progress in their implementation plans for adopting the new standards…”-Wesley Bricker, Interim Chief Accountant, Office of the Chief Accountant

Areas of Focus

Presentation title[To edit, click View > Slide Master > Slide Master]

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Copyright © 2016 Deloitte Development LLC. All rights reserved.36 USC 220506



65Copyright © 2016 Deloitte Development LLC. All rights reserved.

AgendaAccounting & Auditing Update

Revenue recognition implementation efforts

FASB standard setting

Deep Dive: Leases

Question and answer


Keep in mind

This presentation does not provide official Deloitte & Touche LLP interpretive accounting guidance.


Learning objective

To enhance participants’ understanding of important accounting issues and developments pertaining to recent actions of standard setters, regulators, and others.

ASC 606 – Revenue recognitionImplementation efforts


FASB & IASB boards• Amend standard for clarifications

and practical expedients

TRG• Inform the boards of

implementation issues• Quarterly meetings

AICPA• 16 Industry-specific working

groups• Audit & Accounting Guides

SEC• Staff announcements

PCAOB

Preparers

Users

Auditors

ASU 2014-09 / IFRS 15 Issued May 2014

Key participantsImplementation efforts


TRGImplementation efforts

Joint Revenue Transition Resource Group

• Jointly discussed about 40 topics in six meetings over approximately 18 months

• Led to standard-setting to further clarify ASC 606

− Four final ASUs and one proposed ASU (regarding certain technical corrections)

• No longer joint (in January 2016, IASB announced it has completed its decision-making)

• Three FASB-only meetings scheduled in 2016

− TRG met in April but did not meet in July

Recent SEC staff comments expressing expectations of U.S. and foreign filers:

• SEC staff will consider TRG discussions and meeting minutes when assessing the appropriateness of a filer’s revenue recognition accounting policies.

− Therefore, filers should monitor and consider such information (i.e., particularly when general agreement is reached).

• Strongly encourage filers to consult with the SEC staff if a filer anticipates selecting an accounting policy that is inconsistent with TRG discussions.

• Although IFRS constituents will no longer participate in TRG meetings, U.S. TRG participants are expected to discuss topics from a global perspective.


No. of issues No. of issues

Aerospace and defense 14 Hospitality 7

Airlines 20 Insurance 6

Asset management 10 Not-for-profit 5

Broker-dealers 9 Oil and gas 3

Construction contractors 11 Power and utility 10

Depository institutions 6 Software 13

Gaming 15 Telecommunications 12

Health care 10 Timeshare 12

Total 163

AICPA industry revenue task forcesImplementation efforts

Number of issues that the task forces are addressing:

http://www.aicpa.org/InterestAreas/FRC/AccountingFinancialReporting/RevenueRecognition/Pages/RevenueRecognition.aspx


Other considerations for SEC registrantsImplementation efforts

SAB Topic 11.M (SAB 74) disclosures

• Important for investors’ “timely education and engagement”

• Disclosure of specific impact of new standard to the registrant expected to be more precise as effective date approaches

• Staff has cited how transparent disclosures regarding the adoption of other new standards prevented adverse market reactions

Revised financial statements in registration statements

• “Fourth” year and impracticability

Consultations and resources

• Office of the Chief Accountant (OCA) has conducted consultations and encourages registrants to consult with OCA

− Regarding complex, innovative transactions without clear guidance

• Topic 11 recently added to Division of Corporation Finance’s Financial Reporting Manual

− Selected financial data, quarterly financial data, ratio of earnings to fixed charges

− Significance tests related to provision of other entities’ financial statements

FASB invitation to commentAgenda consultation


Overview of the agenda consultation

On August 4th, the FASB issued an invitation to comment (ITC) to solicit feedback about potential financial accounting and reporting topics that it should add to its agenda.

The ITC identifies financial reporting issues and possible solutions for the following topics:

1. Intangible assets (including research and development)

2. Pensions and other postretirement benefit plans

3. Distinguishing liabilities from equity

4. Reporting performance and cash flows (includes income statement, segment reporting, other comprehensive income, and statement of cash flows)

The comment period ends on October 17th

FASB invitation to comment


Potential improvements

• Alternative A - Recognize at cost or fair value internally generated intangible assets

• Alternative B - Recognize at cost or fair value research and/or development costs

• Alternative C - Disclose internally generated intangible items

• Alternative D - Adopt IAS 38

Intangible assetsFASB invitation to comment

Issue - lack of overarching recognition and measurement framework for internally developed intangible assets


Potential improvements• Alternative A - converge with IAS 19, Employee Benefits

• Alternative B - eliminate all smoothing and recognize measured changes immediately in the income statement

Pensions and other postretirement benefitsFASB invitation to comment

Issue - Delayed recognition (smoothing) in earnings

The FASB is also considering whether a comprehensive change to pension and postretirement benefit plan accounting would be more effective


Distinguishing liabilities from equity

The issue - current GAAP is:

1. Difficult to navigate and

2. Internally inconsistent, conceptually flawed and rules-based (which can lead to financial structuring)

Potential improvements

Holistic approach to determine whether a present obligation to transfer shares of the entity meets the definition of a liability

• Alternative A – Classify an instrument as a liability if there is a present obligation to transfer assets or shares of the entity

• Alternative B – Classify an instrument as a liability only if there is a present obligation to transfer assets

FASB invitation to comment


Reporting performance and cash flowsFASB invitation to comment

Issues Potential improvements

Income statement

1. Categorize the income statement into operating and nonoperating activities

2. Combining or separating performance information and presenting discrete lines

Othercomprehensive income (OCI)

1. Minimize the use of recycling2. Remove the option for presenting comprehensive income over two

statements3. Emphasize other earnings-per-share measures

Segment reporting

1. Reexamine disclosure requirements of ASC 2802. Reexamine aggregation criteria3. View segment reporting from a governance perspective

Statement of cash flows

1. Targeted improvement to provide further disaggregation of specific cash flows

2. Provide additional classification guidance for certain types of cash flows3. Reconsider definitions of each classification category and the three-

category structure


AgendaDeep Dive: Leases

• The “Big Picture”

• Identifying a lease

• Key ingredients of the leases model

• Overview of the core accounting models

• Other provisions, transition, and effective date

• Operational considerations

• Question and answer


Key takeaways from this Dbriefs webcastThe “Big Picture”

Most leases on balance sheet for lessees

Classification will drive expense profile

Lessor model largely unchanged

Most changes result from alignment with ASC 606

FASB tried to make things easy

Classification, reassessment, transition

Effective 2019 but don’t wait to assess impact

Process and systems changes may be requiredPotential impact on debt covenants

Identifying a lease


Scope

What’s in and what’s out?Introducing the new standard

Applies to leases of property, plant, or equipment

Does not apply to:

Leases of intangible assets

Leases to explore for or use nonregenerative resources

Leases of biological assets

Leases of inventory

Leases of assets under construction


A lease is a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment for a period of time in

exchange for consideration

ConsiderationLessor Lessee

Control the use of an identified asset

What does the new definition look like?Definition of a lease


Definition of a lease

For a contract to be, or contain, a

lease it must

Depend on the use of an identified

asset, and

Convey the right to control the use

Right to obtain substantially all of the economic benefits from

asset use

Right to direct the use of the asset over lease

term

and


Identified asset criteriaIdentified asset — Overview

Contract must depend on use of identified asset• Asset must be explicitly or implicitly identified• Physically distinct portion of a larger asset may be an identified asset• Capacity portion of a larger asset is generally not an identified asset

Right of substitution• Would result in the asset not being deemed a specified asset• Substitution would be considered substantive if . . .

o Lessor has the practical ability to substitute the asseto Lessor would benefit from exercising its right of substitution

Warranty or upgrade considerations• Supplier’s right or obligation to substitute an alternative asset due to operational failure

does not mean the asset is not an identified asset • Supplier’s right or obligation to upgrade the asset similarly does not mean the asset is

not an identified asset


Benefits related to the ownership of an asset should not be included in the assessment of whether an arrangement contains a lease

Can obtain economic benefits from the use of an asset directly or indirectly in many ways

Economic benefits from the use of an asset include its primary output and by-products, including potential cash flows derived from these items

RIGHT TO OBTAIN SUBSTANTIALLY ALL OF THE ECONOMIC BENEFITS FROM USE

Convey the right to control the useDefinition of a lease


Protective rights, while defining the scope of the asset use, generally do not, in isolation, prevent the customer from being able to direct the

use of the asset

• Right to direct “how and for what purpose” asset is used throughout the period of use; or

• Relevant decisions about “how and for what purpose” asset is used are predetermined before the period of use, and Customer has the right to operate asset without supplier having the right to

change operating instructions; or Customer designed the asset in a way that predetermines the most relevant

decisions about how and for what purpose the asset will be used during the period of use

RIGHT TO DIRECT THE USE OF THE ASSET

Convey the right to control the use (cont’d)Definition of a lease


CONTRACT FOR THE USE OF A SHIP — FACTS

Customer A enters into a contract with Supplier B for the use of a specific ship for a four-year period

• Supplier B is not permitted to substitute the ship• Customer A decides whether and what cargo will be transported and when and to

which ports the ship will sail throughout the contract period• Certain restrictions prevent Customer A from sailing the ship in waters where there is

a high risk of piracy or from carrying hazardous materials as cargo

• During the contract period, Supplier B operatesand maintains the ship and is responsible for the safe passage of the cargo onboard the ship

• Customer A is prohibited from hiring another operator for the ship during the term of the contract or operating the ship itself

Illustrative exampleDefinition of a lease


CONTRACT FOR THE USE OF A SHIP — ANALYSIS

In this scenario, A has the right to control the use of the ship throughout the four-year contract period

• Customer A has the right to obtain substantially all of the economic benefits from the use of the ship during the contract period through its exclusive use of the ship

• Customer A has the right to direct activities related to the use of the ship because it decides where and when the ship will travel, what cargo it will carry, or whether it will be transporting cargo at any given time

• While there are contractual restrictions about where the ship can sail and the nature of the cargo to be transported, these are protective rights and do not prevent Customer A from having the right to direct the use of the asset

Illustrative example (cont’d)Definition of a lease

Key ingredients of the leases model


Separating lease and nonlease components

An asset will be considered a separate lease component if:

• Lessee can benefit from the use of the underlying asset either on its own or using other resources that are readily available

• The underlying asset is not highly dependent on or highly interrelated with other assets in the arrangement

NOTE: Land and other elements evaluated separately unless the accounting for the land element would not be significantly different

Contracts with multiple lease components for different

underlying assets

Contracts with lease and nonlease components

(i.e., separate services)

An activity is a nonlease component if it transfers a good or service to the lessee

• CAM and utilities would likely be nonleasecomponents

• Property taxes and insurance would likely be combined with the lease component(s)

Standard provides specific lessee and lessor guidance on how consideration should be allocated to each contract component

Contracts that contain multiple components


Lease would be classified as a finance lease (lessee) or a sales-type lease (lessor) when . . . Lease transfers ownership of the underlying asset to lessee by the end of the lease

term Lease grants the lessee an option to purchase the underlying asset that the lessee is

reasonably certain to exercise Lease term is for a major part of the remaining economic life of the underlying

asset Present value of the lease payments and any residual value guaranteed by the

lessee equals or exceeds substantially all of the fair value of the underlying asset Leased asset is so specialized in nature that it is expected to have no alternative use

to the lessor at the end of the lease term

Overview of the criteriaLease classification

CLASSIFICATION CRITERIA

The standard states that the bright-line thresholds that exist under ASC 840 could be a reasonable approach to evaluate whether a lease would be classified as a finance lease


Initial determination and reassessmentLease term

LEASE TERMNoncancelable period, plus… Renewal options that are reasonably certain to be exercised by a lessee Termination options that are reasonably certain not to be exercised by a lessee Options to extend (or not to terminate) that are controlled by the lessor

REASSESSMENT REQUIREMENTSLessees are required to reassess lease term when A significant event or change in circumstances occurs that is in the control of the

lessee A contract term obliges the lessee to exercise (or not exercise) a renewal or

termination option Lessee elects to exercise or not exercise a renewal or termination option that was

not previously deemed reasonably certain of being or not being exercised Would reassess when there is a modification that does not result in a separate

contractLessors would not be required to reassess lease term, unless there is a modification that does not result in a separate contract


What amounts are included in lease payments?Lease payments

•Payments specified in the lease agreement

•In-substance fixed paymentsFixed lease payments

•Payments that depend on an index or a rate•Excludes payments based on usage or performance•Reassessment required under certain circumstances

Variable payments

•Lessees — amount that it is probable will be owed under the RVG at the end of the lease term

•Lessors — the full amount at which the residual asset is guaranteed by the lessee or third party

Residual value

guarantees

•Treated in a manner consistent with the accounting for renewal options

•Include options that a lessee is reasonably certain to exercise

Purchase and termination

options


What discount rate should be used?Discount rate

Lessee must use the rate the lessor charges in the lease if readily determinable or, alternatively, its incremental borrowing rate

Lessor would use the rate it charges the lessee, which is known as the rate implicit in the lease

Nonpublic business entities are permitted to make an accounting policy election to use the risk-free rate when measuring their lease obligations

REASSESSMENT REQUIREMENTS

Lessee Lessor• Would generally be updated when there

is a remeasurement of the lease obligation

• Would reassess when there is a modification that does not result in a separate contract

• Would reassess, in certain instances, when there is a modification that does not result in a separate contract

Overview of the core accounting models


What does the lessee model look like?Lessee accounting model

InitialMeasurement

Most* leases are recorded on the balance sheet using a right-of-use asset approach:

SubsequentMeasurement

• Lease obligation — PV of lease payments not yet paid• ROU asset — lease obligation + initial direct costs – lease

incentives + prepaid lease payments

• Lease obligation — amortized using the effective interest method

• ROU asset — depends upon lease classification • Expense recognition pattern:o Finance lease — front-loadedo Operating lease — generally straight-line

Short-term leases: A lessee can elect, by asset class, not to record on its balance sheet a lease with a lease term of 12 months or less and which does not include a purchase option that the lessee is reasonably certain to exercise

*


Illustrative exampleLessee accounting model

Finance lease Operating lease

This table highlights the differences in accounting for the lease under the finance lease and operating lease models:


What does the lessor model look like?Lessor accounting model

• Existing lessor accounting retained with minimal changes• Classification depends on an assessment of control of the underlying asset

Sales-type Direct financing Operating• Lessee gains control of the

underlying asset

• Underlying asset is derecognized

• Net investment in a lease is recognized

• Selling profit or loss recognized at lease commencement

• Initial direct costs recognizedat lease commencementunless no selling profit or loss

• Lessee does not obtain control of the asset, but the lessor relinquishes control

• Underlying asset is derecognized

• Net investment in a lease is recognized

• Profit deferred and amortized into income over the lease term

• Initial direct costs deferred and amortized into income over the lease term

• Lessor retains control of the underlying asset

• Underlying asset remains on the lessor’s balance sheet

• Income recognized on a straight-line basis unless another systematic basis is more appropriate

• Initial direct costs deferred and expensed over the lease term in a manner consistent with income


New lessor guidance aligned with the FASB’s new revenue standard

in many respects

Interaction between ASC 842 and ASC 606Lessor accounting model

Sale treatment linked to lessee

control of underlying asset

Sale recognition depends on whether collectibility of the

lease payments plus the residual value

guarantee is probable

Must consider guidance in

ASC 606 when determining how to allocate payments between lease and

nonlease components

Lease modifications

accounted for in a manner similar to the modification

guidance in ASC 606

Determination of initial direct costs linked to

incremental costs of obtaining a contract in ASC 606


ROU assetLease liability

Amortization expenseInterest expense

Principal (Financing)

Interest (Operating)

ROU assetLease liability

Lease expense (single line on straight-line

basis)

Lease payments

(Operating)

Balance Sheet Income Statement Cash Flow Statement

Financing Lease

Operating Lease

Presentation requirements

Lessee model

Presentation consistent with current lessor model:• Balance sheet — presentation depends on lease classification• Income statement — profit or loss recognized in a manner consistent with business model• Cash flow statement — recognized as cash inflows from operating activities

Lessor model


Disclosure requirements

DISCLOSURE OBJECTIVEEnable financial statement users to assess the amount, timing, and uncertainty

of cash flows arising from leases

LESSEE DISCLOSURES Nature of its leases Information about leases that have not

yet commenced Related-party lease transactions Accounting policy election regarding

short-term leases Finance and operating lease costs Short-term and variable lease costs Sublease income Gain or loss from sale-and-leaseback Maturity analysis for lease obligations Weighted-average remaining lease

term Weighted-average discount rate

LESSOR DISCLOSURES Nature of its leases Significant assumptions and

judgments used Related-party leases transactions Tabular disclosure of lease-related

income Components of the net investment in

a lease Information on the management of

risk associated with residual asset Maturity analysis of operating lease

payments and lease receivable Information required by ASC 360

Other provisions, effective date, and transition


Sale-and-leaseback transactions

• Seller-lessee should evaluate the transfer of the underlying asset under the requirements of ASC 606

• Existence of leaseback would not prevent a conclusion that underlying asset was sold

−Arrangement in which leaseback is classified as a finance lease would preclude sale accounting

• Substantive repurchase options would preclude sale accounting

•Entire gain resulting from the sale recognized immediately•Special considerations for off-market terms

Gain recognition

•Account for leaseback in a manner consistent with other leases•Seller-lessee applies lessee model; buyer-lessor applies lessor model

Leaseback accounting

•A “failed sale” will be accounted for as a financing arrangement by both parties

“Failed” sale-leaseback


Current “build-to-suit” guidance is not carried forward in the new standard

Lessee controls asset during construction

• Asset is effectively owned by the lessee during theconstruction period

• Arrangement would be subject to sale-and-leasebackaccounting upon completion of construction

Lessee does notcontrol asset during

construction

• Costs related to the construction or design of the underlying asset would be accounted for under other U.S. GAAP topics

Standard provides indicators a lessee should consider when evaluating whether it controls the asset being constructed

New accounting depends on whether the lessee

controls the underlying asset during the construction period:

Lessee involvement in asset construction


Effective date• Public business entities — effective for calendar periods beginning on January 1, 2019

and interim periods therein• All other entities — effective for calendar periods beginning on January 1, 2020, and

interim periods thereafter• Early adoption will be permitted

• Lessees and lessors are required to use a modified retrospective transition method for all existing leases

• Would apply the new model for the earliest year presented in the financial statements• Application of approach linked to current lease classification and new lease classification• An entity can use hindsight when evaluating lease term

Transition

TRANSITION RELIEF PACKAGELessees and lessors are not required to reassess the following upon transition: Whether any expired or existing contracts are leases or contain leases The lease classification for any expired or existing leases Initial direct costs for any existing leases

Effective date and transition


But wait, there’s more…Other key provisions and resources

Lease modifications Contract combinations Sublease accounting Leveraged lease accounting Accounting for leases at a portfolio level Leases in a business combination Related-party leases Accounting for leasehold improvements Impairment considerations US GAAP to IFRS comparisonFASB’s new standard brings most leases onto the balance sheet*Read the complete Heads Up” via the link to your left in the console.

Operational considerations


What to look for

High lease volume

Complex lease contracts

Disparate systems/spreadsheets

Decentralized lease transaction processing

International locations

Prior challenges in lease accounting

Potential M&A activity

As you prepare to implement the new lease accounting standard, the following indicators may suggest a higher level of work effort:


Internal Controls

High volume of data fields

Multiple currencies

and languages

Judgment requirements

Information isn’t all in one

agreement

Different arrangements

in different countries

Data housed in disparatesystems

During the implementation period, your operations don’t cease. New leases are entered into and existing leases are modified or terminated

Internal‏controls

Operational challenges — Data

The reporting and disclosure requirements of the new lease accounting standard may result in an increase in electronic data needs and a long lead time to abstract and validate data. Factors to consider may include:


As you review your current lease technology capabilities the following functional requirements should be considered:

Abstraction technology to support efficient data gathering for large volumes of leases

Storage of electronic lease documents and related data fields

Reporting capabilities to perform necessary calculations and create required disclosures

Operational considerations including key event notifications, “what if” analyses, workflow management, and data analytics

Technology changes may be a longer lead time activity which may necessitate a temporary solution to facilitate data capture and pro forma reporting

Operational challenges — Technology


The following additional challenges should be considered as you plan your implementation roadmap:

Application of Judgment and Estimation

Debt Covenants

Data Management

Internal Controls and Business Process Environment

Training

Income Taxes

Judgment is often required in the lease assessment; proper documentation is critical

Increased scrutiny from auditors and regulators may require entities to reexamine their internal controls and processes

Careful examination of the effects of increased leverage and potential debt covenant violations will be required

Potential tax implications are situational, which requires entities’ tax department involvement

Third-party data may be needed to ensure a high level of operational quality and efficiency

Entities may need to establish change management andemployee training programs

Other implementation considerations


Initial steps to understand and plan the road aheadGetting started

Understand the accounting requirements

1 Understand the lease population

2 Assess capabilities of existing technology

3

Perform a data gap analysis

4 Develop an implementation roadmap

5

Question and answer


ASC: Accounting Standards CodificationASU: FASB Accounting Standards UpdateCAM: Common Area MaintenanceCF: Cash FlowFASB: Financial Accounting Standards BoardFV: Fair ValueIASB: International Accounting Standards BoardIFRS: International Financial Reporting StandardsIT: Information TechnologyP&L: Profit and LossPV: Present ValueROU: Right-Of-Use

Acronyms used in presentation


Contact info

Bob UhlPartner, Deloitte & Touche [email protected]

Connect with me on LinkedIn

James BarkerPartner, Deloitte & Touche [email protected]

Stephen McKinneyDirector, Deloitte & Touche [email protected]


Tim KolberSenior Manager, Deloitte & Touche [email protected]


Sean TorrDirector, Deloitte & Touche [email protected]



https://www.linkedin.com/in/bob-uhl-0025292b



https://www.linkedin.com/in/stephen-mckinney-06316537

https://www.linkedin.com/in/tim-kolber-4343535


https://www.linkedin.com/in/sean-torr-58764b20


This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.


Copyright © 2016 Deloitte Development LLC. All rights reserved.36 USC 220506Member of Deloitte Touche Tohmatsu Limited



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