Comment Letters

The boards have received 600 comment letters with a few stragglers still dribbling in (they never turn away a late comment letter — so write one and send it in!). The rough breakdown of the responses is that only about 5%-10% of the letters are fully supportive of the ED. Those positive letters are typically from other standard setting bodies (the theoretical versus practical accountants). About 10%-15% agree with capitalizing operating lease obligations but have significant issues with the ED, which they point out as weaknesses that the boards need to address. The remaining 75%-85% are negative, many of which say the proposed rules are not an improvement over current leasing GAAP. The group of negative letters includes all the major accounting firms — and that has to tell you something.
Outreach Meetings

The boards are in the process of seeking additional feedback through outreach meetings and roundtable sessions. They have finished 35 outreach meetings with 220 analysts around the world, and they report that most all the analysts agree with the ED (note they say most — and it remains an issue that not all users of financials agree with the ED, most notably lenders to small, medium and non-investment grade companies, which are the primary buyers of equipment lease products). The board and staff design their questions so that most would agree. For example, I could ask you, “Do most operating leases create enforceable obligations?” You would agree, yet you may not agree with the details of the ED.

The report on outreach to analysts also says that most analysts consider operating leases to be debt-like obligations. But notice the analysts do not say operating lease obligations are in fact debt. In my opinion, the boards and their staff gloss over these nuances that are important to users of financial statements of lessees. In any event, the report is available, if you chose to read it, on the FASB website. It is a mystery to me that the boards say that analysts agree with the ED, yet the Investors Advisory Committee (IAC), a group made up of analysts whose sole mission is to provide advice to the FASB, has submitted a negative comment letter saying, “IAC does not support the lease proposal because it is not an improvement to current U.S. GAAP lease accounting.” Among the reasons cited are: “IAC does not consider the economic substance of an equipment lease and a property lease to be different, therefore, the income statement and cash-flow measurement and presentation should be equivalent,” and “the majority of analysts have traditionally viewed the current lease accounting’s income statement and cash-flow statement measurement and presentation as an accurate representation of the economic substance of a lease. The proposal is not an improvement to current accounting in these areas.” I say they have to address those issues and change them.

Roundtable Meetings

The boards have held roundtable meetings with organizations that submitted comment letters to get more detailed feedback. I attended one session and observed three others. The discussions at most of the meetings raised the following issues, which are all important advocacy positions of the ELFA and the equipment leasing industry:

Lessee Accounting

• Current IAS 17 classification tests would result in accounting that more closely matches the legal nature and economics of leases to lessees.
• Current GAAP for P&L (straight line rent expense for operating leases) and cash-flow presentation would also be an improvement.
• Operating lease obligations are not debt in bankruptcy and unless clearly labeled as non-debt liabilities there will be unintended technical debt covenant defaults by lessees.
• It would be best to retain the current rules and definitions regarding options to renew or buy that are based on whether a bargain or penalty for failure to exercise exists. These terms are well understood and are in line with the boards’ intentions. The boards were asked to avoid “change for the sake of change” on other areas as where current GAAP works fine.
• Proposed rules that negate sale treatment in sale leasebacks with non-bargain purchase options will cause issues with many equipment leases that are sales for UCC and tax purposes.
• It will be infeasible for lessees to bifurcate the service portion of bundled billed full-service leases unless they allow reasonable estimates to be used rather than the need to find like lease or service contract pricing in the marketplace. Leases and service contracts are unique, so market pricing information is not readily available.

Lessor Accounting:

• Current GAAP works well and could be left alone.
• Business model (operating versus financial) should be used to classify leases for lessors as it best reflects the economics to users for financial statements.
• Tax credits/benefits should not be ignored in lease revenue recognition.
Complexity/Cost
• Lessee Type B accounting and re-assessment accounting is too complex and could be simplified if the straight line average rent was used as the P&L cost.
• Lessor Type B accounting is only cosmetically different than current GAAP, so why change it?
• Transition accounting is too complex where every lease must be reviewed by both lessees and lessors to determine if it originated as a sale leaseback. Also lessors must determine a current fair value (not readily available) for each asset (too burdensome to do on an asset-by-asset basis) when transitioning from operating lease accounting and leveraged lease accounting to the new Type A lessor accounting.

Timeline

The staff will read all the comment letters. They will compile the results of outreach and roundtable meetings with the results of the comment letters. They will prepare a report in November that summarizes the results and makes recommendations for issues raised that the boards should address in re-deliberation meetings. It is expected that re-deliberations will begin in December. Considering the volume of comments and the nature — many hit at the core underpinnings of the ED — the re-deliberations may be long and contentious. It is unlikely that the boards would issue a new ED (that is a judgment call as to whether changes to the current ED rise to the level that merits a new round of public comments). They are likely to finish the re-deliberations in mid- to late 2014. There is a real chance that the transition date could slip to 2018, although if they cut out much of the complexity by moving closer to current GAAP, they still could set a transition date of 2017.

Where will it all end up?

I admit that I have prejudiced views, so I think they will agree to change the ED to address the issues and solutions raised in the letters and at the meetings. I think that the key player in this last phase is the IASB, which seems to have hardened its views that the ED is fine as-is because the IASB thinks it provides improved information for users and that equipment leases are financings. The IASB still wants a one-method solution for lessees with front-loaded P&L costs. The FASB seems to be more open to the feedback and will have to convince the IASB to compromise in addressing the concerns that have come in loud and clear in the feedback. My recommendation, which I presented at my roundtable meeting, was to drop convergence if compromise on the major issues cannot be reached. Leasing is too pervasive in the U.S. not to have alignment of the accounting with the legal and tax views based on the substance of lease transactions.

On the lessee side, the question of whether operating lease obligations belong on the balance sheet is not open for debate, but all other issues raised are. I think the FASB is open to move to IAS 17-based classification, P&L and cash-flow treatment. I believe there will be a two-lease solution with balance sheet presentation that will avoid debt covenant breakage. I am hopeful that they will give some relief regarding bifurcating services in a gross or bundled billed lease. I am fearful that they will not relent on the sale leaseback with a purchase option decision.

On the lessor side, I think the need for symmetry will be dropped and they will adopt a business model approach that will allow “operating” equipment lessors along with real property lessors to use the operating lease method.

Regarding complexity, the closer they get to current GAAP, the less the complexity in the areas of lease classification and P&L accounting. One must have to accept that there will be more complexity just because lessees have to capitalize operating leases.

Bill Bosco is the principal of Leasing 101, a lease consulting company. He can be reached at [email protected], www.leasing-101.com or 914-522-3233.