FASB Leases Project Update: Two Decisions May Harm the Industry, One Will Help

by By Bill Bosco Sep/Oct 2014
Monitor contributor Bill Bosco discusses two major issues discussed at a recent FASB meeting and how leveraged lease and sale leaseback accounting changes may affect the industry at large.

The FASB discussed two major FASB-only issues at its meeting on August 27. The Board dealt with leveraged lease (LL) and sale leaseback (SLB) accounting (where the leaseback has a purchase option). The leveraged lease issue is a major issue for most large ticket lessors and the sale leaseback issue is a major issue for most lessors. The ELFA has been commenting on these issues throughout the project in comment letters and in meetings.

Sadly, the FASB received only one comment letter on the LL issue and only two comment letters on the SLB despite their importance to industry members and our customers. I cannot understand the reluctance of lessors to send comments to the FASB. There are no repercussions possible (it’s not like you are commenting to the IRS or SEC). Most importantly, the board values and uses feedback to help make the right decisions. If FASB doesn’t receive comment letters, it naturally infers that it has made the right decisions.

The Key Decisions

Leveraged Leases: The FASB reaffirmed its decision to eliminate leveraged lease accounting for all new arrangements closed after the transition date in a close 4 to 3 vote. A little piece of me died when I saw only three hands go up in support of maintaining leveraged lease accounting. However, in a pleasantly surprising vote, the board tentatively decided to allow entities to continue to apply the current leveraged lease guidance to leveraged lease arrangements that exist as of the final standard’s effective date.

Commentary: The decision to grandfather leveraged leases in existence at the transition date is good news on two fronts. First, the cost, complexity and misleading financial reporting that would have resulted from unwinding existing leveraged leases is avoided. Second, it allows time to execute new leveraged leases up until the transition date, which although undecided, is likely to be no earlier than 2018.

The decision to eliminate leveraged lease accounting was expected but it was not anticipated to be as close as it was. It is an unfortunate decision as the cost-effective benefits of leveraged leases executed beyond the transition date will be lost to lessees. It disturbs me that many of the largest lessors did not comment to the FASB. Had we received more comment letters, the board may have voted differently.

Sale Leasebacks: The board decided to follow the recently issued revenue recognition guidance and clarified that a repurchase option exercisable only at the then-prevailing fair market value would not preclude sale treatment, provided that the underlying asset is non-specialized and readily available in the marketplace. The repurchase option must be substantive (the FMV option, with caveats, as FASB voted is not considered substantive) in order to affect the accounting for the SLB transaction. In reaching this decision, some board members said that this application was consistent with language provided in the basis for conclusions of the recently issued Revenue Recognition Standard.

I strongly believe that the board would not have allowed even FMV purchase options if it did not receive the two comment letters explaining the issues in SLBs with purchase options. For those keeping track of the project, you know the board tentatively decided that any purchase option allowed the lessee to control the asset and would negate sale treatment.

In other words, the board decided that a seller-lessee’s option to repurchase an asset would not prevent the seller-lessee from concluding that the underlying asset was sold if the asset is a non-specialized asset and the exercise price is at fair value. The board also tentatively decided that the final standard would include application guidance regarding how repurchase options should be evaluated.

FASB did not specifically discuss non-bargain fixed price purchase options, but that means that their presence in the leaseback terms would preclude sale treatment in a sale leaseback. Leasebacks with fixed purchase options would be failed sale-leasebacks.

The board tentatively reaffirmed the guidance that the seller-lessee and buyer-lessor should account for a failed sale leaseback transaction as a financing arrangement, but asked the staff to come back at a future meeting to present detailed failed SLB accounting.

Commentary: This decision is a serious setback as a failed sale leaseback, where the leaseback is a Type B/operating lease but has a non-bargain fixed price purchase option, meaning that it counteracts the good decision that the Board made regarding the financial statement presentation of a Type B/operating lease. That decision was that the lessee’s asset and liability in a Type B/operating lease are unique in that the asset is not a physical asset and the liability is not debt.

To record a failed sale leaseback, where the leaseback is a Type B/operating lease, means that the whole asset stays on the lessee’s books and the proceeds received are accounted for as a loan (debt). From a legal perspective, that presentation is not representative of the substance of the SLB transaction. It will mislead lenders, credit analysts and other key users of financial statements who need to know the real/true owned physical assets and the true debt of a preparer. Hopefully when the board examines the results of a failed sale leaseback accounting example it will revisit this decision.

The decision to allow FMV purchase options in non-specialized assets sale leasebacks is a good decision as it reflects the substance of that type of transaction.

It will be interesting to see how the board handles the transition, as sale leasebacks are very common in all types of equipment leases, and a fixed price non-bargain purchase option is a common term. If, in transition, lessees and lessors are forced to reevaluate every sale leaseback present in their lease portfolio, it will be a costly exercise and would have significant financial reporting implications if all those leases are to be re-booked and accounted for as financings. Think about the fact that lessors sell their interest in leases on the secondary market. The second lessor really never cares if the original transaction was an SLB. If SLBs are not grandfathered, lessors would have to retrieve and read the documents on every lease.

There is still hope. At the ELFA’s recent accounting conference, Tom Linsmeier, the FASB Board member invited to speak, was asked a few questions from the audience, and he requested for the questions to be sent as a comment letter to FASB. One question asked: When is a lessee considered an owner of an asset in a SLB? Many assets involve the lessee committing to purchase, paying deposits, progress payments and down payments. The board needs to clarify, or we need to understand, the new concept of transfer of control, defining when a sale takes place under the newly issued Revenue Recognition Standard. It may be that since the lessee has not fully performed its obligation, a sale has not taken place.

Another question centered on those SLBs that occur as a convenience in a master lease (where the lessee funds individual assets and the lessor does a once-a-month mass SLB). In this case the lessee may be acting as an agent and not a principal to the transaction. Whether one is an agent or a principal is a consideration under the Revenue Recognition Standard regarding sale treatment, and we need to understand how to structure new SLBs to qualify as sales.
The last comment from the audience stressed the complexity in transition of requiring lessees and lessors to examine every lease with a purchase option to see if it would be a failed SLB, suggesting that grandfathering be considered. Linsmeier suggested that the Board would consider these issues if presented in a comment letter.

Gary Kabureck, an IASB board member, was also on the panel with Linsmeier. Both Linsmeier and Kabureck said the FASB and IASB appreciated the comments from the ELFA throughout the Leases Project as they provided needed details and positive suggestions to help the boards with the complex issues in lease transactions.

Next Steps in the Project

While the boards have redeliberated many aspects of the proposed leases model, they still need to discuss a number of issues, including the following:

  • Lessee disclosures
  • Transition
  • Effective date

Bill Bosco is the principal of Leasing 101, a lease consulting company. Bosco has more than 37 years of experience in the leasing industry. His areas of expertise are accounting, tax, financial analysis, structuring, pricing and training. He has been on the ELFA accounting committee since 1988 and was chairman for 10 years. He is a frequent author and speaker on leasing topics. He has been selected to the FASB/IASB Lease Project working group. He can be reached at [email protected], www.leasing-101.com or 914-522-3233.

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