Lease Project at an Impasse?
The FASB/IASB Lease Accounting Project was supposed to be winding down with only one or two meetings to clean up loose ends. The boards had meetings on February 28 and 29 with the objective of changing the proposed lessee lease cost pattern in the new exposure draft, as it had been the subject of so much negative comment. The other objective was to re-look at the proposed lessor accounting methods, if a decision on the lessee side warranted it, reason being that some think there should be symmetry between lessee and lessor cost and revenue patterns.
As it has been widely reported, the boards did not get very far on the lessee question. In fact, they may have reached an impasse and they never got to the lessor issues. The issue under consideration was the front-loaded cost pattern of the right of use (ROU) method for lessees whereby the ROU asset is amortized straight line and interest is imputed versus the ROU liability amortizing using “interest-based” amortization. The majority of comment letters received by the boards said that there are two types of leases as per current GAAP — leases that transfer ownership (AKA capital leases) and leases that merely transfer a temporary right of use (AKA operating leases).
The comments said further that the P&L cost pattern should be different with only former capital leases having a front-loaded cost pattern while the former operating leases should have a level cost pattern. As it turns out, the FASB agrees while the IASB does not. The IASB thinks that all leases should be accounted for the same, citing one of the project’s initial objectives — to eliminate different accounting for similar leases that is an issue under FAS 13 with its bright line PV test. The IASB seems to ignore that the main difference in current lease accounting is capitalization — not the P&L cost pattern.
The staff presented three alternative lessee P&L methods at the meetings — the currently proposed ROU method, a new “interest-based” amortization (IBA) method and a new “underlying asset” (UA) based method. The IBA method would result in straight line P&L if the rents are level. The IBA method would only be applied to the former operating leases while the former capital leases would use the ROU method as they do under current GAAP. The UA method would result in a P&L pattern driven by the depreciation of the leased asset had the lessee owned it using the expected residual as the salvage value. The UA method would only produce a straight line pattern if the asset’s residuals are 100% of its fair value at inception (only possible in a real estate lease). The UA pattern would be applied to all leases.
Both new methods were cited as being complex and possibly not operational (unworkable) by lessees. When the boards voted, they were split with the FASB voting for the IBA method and the IASB voting for the UA method. A question was asked whether any board members would support the other method if their method proved to be unworkable. The result was no one would switch his or her vote. This is a potential impasse. The next steps they decided on were whether to have the staff do more work on the new methods and get feedback from users and preparers. They plan on having one more meeting to see if they can come up with a compromise that deals with the P&L pattern issue.
The IASB thinks all leases should be accounted for the same, citing one of the project’s initial objectives — to eliminate different accounting for similar leases that is an issue under FAS 13 with its bright line PV test. The IASB seems to ignore that the main difference in current lease accounting is capitalization — not the P&L cost pattern.
They did talk about what might happen, and I think three of the four possible outcomes are good for the U.S. leasing industry. One approach is to keep current GAAP with better disclosures and adopting IAS 17 classification tests that are more substance-based than FAS 13’s. A second approach is to part ways and issue separate rules (the FASB would then adopt a straight line method). The last approach has two possible outcomes. That is, they come up with a compromise and that could be good or bad for the U.S. if the compromise is a front-ended cost pattern.
The net of it all should be good for the industry. They have listened to us (especially the FASB) and they are taking the time to try to come up with a standard that reflects the economics of our business.
— Bill Bosco,
President, Leasing 101