The Monitor's resident lease accounting expert Bill Bosco brings us current on the first 2014 meeting of the FASB and IASB. Offering his commentary on key aspects of the deliberation, he notes that the boards are far apart on lessee accounting and certain lessor issues, but both agree that they should reduce the complexity and cost to comply wherever possible.
The FASB and IASB held a joint non-decision making meeting regarding the lease accounting project on January 23, 2014. The staff has reviewed the 641 comment letters and the results of the numerous roundtables and outreach meetings related to the second lease project Exposure Draft (ED2). The purpose of the meeting was for the staff to identify issues it recommends for deliberation at future decision making board meetings and recommend the way forward.
The next meeting will be in March, and it should be very interesting, as the boards are far apart on lessee accounting and some of the lessor issues. They all agree that they should reduce the complexity and cost to comply wherever possible.
The staff said ED2 feedback results indicated current lessor accounting was not in need of significant overhaul. With that in mind, the staff offered three choices for the way forward for lessor accounting discussions and decision making:
1) Use current GAAP;
2) Use current GAAP with sales type accounting only if the lease transfers “control” to the lessee per the proposed Revenue Recognition standard; or
3) Use business model (“finance” lessors use finance lease accounting and operating lessors use operating lease accounting for all their leases).
The boards and staff seem to agree that the current lessor finance lease accounting method should be retained with some exceptions, such as separately presenting the residual asset on the balance sheet. This should be well-received by lessors as the Type A/Receivable and Residual method proposed in ED1 and ED2 would have meant significant costs to revise systems, yet the revenue recognition pattern and the net asset reported on the balance sheet would be identical to current finance lease accounting.
Business model as an approach did not get much discussion time. Business model is the approach that I favor, as it best reflects the substance of the lessor’s business. Specifically “financial” lessors such as banks and finance companies that view each lease as a discreet financial transaction (intending to dispose of the asset if returned) would use finance lease accounting. “Operating” lessors who take positions in equipment/real estate and intend to continue to maintain and release that asset to multiple lessees should use operating lease accounting for all their leases.
A move to control as the basis for sales-type accounting would reduce the number of leases qualifying for gross profit recognition (AKA sales type lease accounting). It does seem logical to conform to the Revenue Recognition thinking, and both boards seem to like it. In my opinion, though, the right answer is to use business model with control and third-party involvement in the residual (like a buy-back agreement or residual guarantee/insurance) as the basis for determining if the lessor can use sales type accounting. The staff did not recommend allowing third-party buy backs or residual guarantees/insurance to influence profit recognition for lessors, as they only view the lease as a sale from the lessee side of the lease transaction (does the lessee get control?) — it would seem that a lessor could sell the current use rights in an asset to one entity (the lessee) and the residual rights to another entity and still get sale treatment.
In discussions at the meeting, the FASB seems ready to give up symmetry in lessee and lessor lease classification, but some IASB members seem to want to keep the issue on the table. The staff and boards are sympathetic to equipment lessors in the operating lease business, as they discussed useful life issues that could change classification if business model is not used. Lessors should generally be okay with any of the three choices that will be deliberated except for the restrictions on sales-type accounting, the likely loss of leveraged lease accounting and maybe the limited view of third-party involvement affecting sale accounting.
Lessee Small Ticket
The boards are leaning toward keeping the ED1 and ED2 definition of short-term lease for an exemption from capitalizing operating leases, but they discussed allowing simplified accounting for other small-ticket leases. The approach they favor is to allow a portfolio approach to account for capitalized immaterial/small-ticket leases. They mentioned using a portfolio approach to account for master leases.
The boards do not seem to realize that portfolio basis accounting will still be complex, as one still has to classify leases (if they go with a two-lease model) and leases have different terms and deliver on different dates. Also, they did not discuss whether to include reassessment of options and accounting for variable payment adjustments in the portfolio-level accounting. Master leases are not all homogeneous, as they may be comprised of lease schedules with different types of assets and lease terms.
The approach to capitalize operating leases is still the driving objective in lessee accounting. The staff offered three choices for lessee accounting discussions/decision making:
1) Treat all leases as Type A (same approach as the first ED);
2) Use the approach in the second ED with most equipment leases treated as Type A leases while most real estate leases would be treated as Type B leases with straight line lease cost; or
3) Use existing GAAP classification tests and straight line rent expense as the lease cost for operating leases, but capitalize all leases.
This was not a good session, as it revealed the continuing differences in views between the FASB and IASB on key issues that are basic to the framework to be applied to lessee accounting. The FASB agrees with the ELFA positions, as it thinks about substance/legal nature of the lease and its treatment in bankruptcy matters in classifying and reporting capitalized leases on the balance sheet and lease expense recognition. On the other hand, the IASB continues to want to discuss the ED1 (a one-lease model where all leases are classified and accounted for as capital leases) and ED2 (a two-lease model that does not reflect the difference between a capital lease and an operating lease for equipment leases) approaches to lease classification and subsequent accounting.
The FASB board members did their best to articulate the need to account for the nature of the asset created and that the accounting for both balance sheet and P&L should be different for different lease types (basically, use existing GAAP). The majority of the IASB still assumes that that all leases create a right of use and see no need to separately disclose the capitalized lease assets and liabilities by their nature. They believe that the only conceptually sound approach is a one-lease Type A model. In my opinion, I agree with the FASB that the lessee model in current GAAP is the only conceptually sound model, as it recognizes that capital leases and executory/operating leases create two distinctly different types of assets and liabilities as well as P&L cost patterns.
The IASB appears to want to ignore two rounds of mostly negative comment letters (a combined 1,400-plus comment letters were received in response to ED1 and ED2), as it continues to want to discuss the approaches in the two Exposure Drafts. We should be beyond that, as it seems to me that those approaches were offered and rejected. One new IASB member did say one should not ignore the legal nature (a lone voice), and one IASB member did say one could view the right of use asset amortization as having a present value factor to justify straight line P&L (but got no support from others).
It appears to me that both chairmen are frustrated with the progress, as the lessee part of the meeting seems to indicate that we will be moving back to re-open old issues.
The staff is to create discussion papers for decision making meetings that will begin in March at a date to be decided. For the lessee discussions the staff does seem to have a difficult task given the divided points of view.
I continue to be optimistic, as I think the FASB will not agree with the IASB on the lessee approaches, which will either force the IASB to agree or the FASB will go its own way. In my opinion the project will be completed in 2014 with an implementation date of no sooner than 2017.
Bill Bosco is the principal of Leasing 101. He 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 ten years. He is a frequent author and speaker on leasing topics and has been selected to the FASB/IASB Lease Project working group. He can be reached at firstname.lastname@example.org, www.leasing-101.com or 914-522-3233.
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