The general direction (still subject to change) of the project allows for accounting differentiation for the industry in that the likely result is that capitalization will be less than ownership, but the complexity burden for small-ticket true leases and the possibility of fair value accounting may cause lessees to buy or borrow to buy equipment to avoid burdensome compliance.

Executive Summary

Implications to ELFA Members
Timetable — It will be 2012 or later before customers and lessors will have to implement new rules.

Materiality — We will not get the bright line we would like to get. It is likely that each lessee will make a judgment as to whether their lease is material.

Balance Sheet for Customers — There are no firm decisions made by the FASB yet. The board is leaning toward the following:

Original Action Plan/Timetable and Comments

FASB/IASB Actions
The FASB and IASB agreed to put a joint project to re-write lease accounting on both of their agendas at their 7/19/2006 meetings. They recruited a working group to act as a sounding board but had only one meeting in February. Besides the working group meeting, the FASB/IASB boards have had only three other public meetings.

FASB/IASB Decisions Made in Public Meetings
Scope — The FASB/IASB decided to limit the scope of the staff’s work to the current scope of FAS 13/IAS 17, that is leases of plant, property and equipment and certain contracts that involve the use of such assets. This was not a decision by the board to limit the scope for an exposure draft and final statement but that remains to be seen.

Observation: The key here is that they may cut back on the project to eliminate intangible assets.

Assets and Liabilities in a Simple Lease —
For the lessee: the assets in a lease are the right to use the leased item and rights to renew the lease or purchase the leased item for a fixed price regardless of whether the options are bargains (they are still considering whether options could be minimum lease payments). The liabilities are the obligation to pay minimum lease payments and any guarantees like residual guarantees.

For the lessor: the assets are the right to receive minimum lease payments and the right to residual proceeds. Presumably there would be no liability as the balancing credit would be to the leased asset to remove it from the lessor’s books.

Neither the lessee nor the lessor will account for the ownership of the leased asset, rather they will account for the rights and obligations in the lease contract on their balance sheets.

The Lease Term — A simple lease with a fixed option to renew has a lease term equal to the base lease term. The renewal is only considered as part of the lease term when and if the renewal option is exercised. A simple lease with an option to terminate has a lease term equal to the non-cancelable lease term. The FASB/IASB realize more work has to be done on defining the lease term in cancelable leases to mitigate the possibility of financial engineering.

FASB/IASB Discussions in Public Meetings
Lessee Accounting for the Capitalized Lease Obligation — The view expressed by most IASB and FASB board members is that the obligation to make minimum lease payments in a lease should be treated as a financial liability. The likely lessee accounting to recognize the lease is to present value of the payments using the lessee’s incremental borrowing rate. Subsequent accounting is likely to use the interest method to record a “principal and interest” component to each lease payment with an option to fair value the liability at each reporting period.

Observation: This method may reflect the reality of a lease that transfers ownership but does not reflect reality of a true lease. Liabilities, like a residual guarantee, are not included in minimum lease payments but would likely be accounted at fair value.

Lessee Accounting for the Asset — Interestingly, the IASB and FASB have distinctly different views on lessee asset accounting. The view expressed by most IASB board members is that the asset is like a temporary ownership and they favor fixed-asset accounting (generally depreciating the asset straight line over the lease term). The IASB seems to want to fit lease accounting into other existing accounting rules for fixed assets and financial liabilities.

The FASB realizes that many leases have special economic and commercial features that require development of special rules and the general consensus was to develop a new method but rely on intangible accounting rules as the starting point (this is in keeping with the idea that the asset is a right-of-use and not ownership). The FASB view is that the staff should consider the economics of leases in their research for the asset accounting.

Observation: Neither board has discussed the distinction between true leases and financings. Neither board has discussed tax benefits in lease accounting.

Lessee Booking Date — In their discussions they recognize that some leases, like third-party leases, should be recorded at delivery and acceptance by the lessee. They recognize that captive finance company leases and leases with complex or long delivery terms may need to be booked at commitment. They will be doing lots more work in this area.