FASB Moves to Issue the Lease Exposure Draft

by Bill Bosco May/June 2013
As FASB held possibly its last meeting on April 10 regarding the proposed lease accounting changes prior to the expected issuance of the new Exposure Draft in mid- to late May 2013, Bill Bosco explains that the project continues to slip and the controversies surrounding the proposed new rules continue.

The purpose of the April 10 meeting of the Financial Accounting Standards Board was to review the cost benefit study done by the staff and to see if the board was in favor of issuing the new Exposure Draft (ED). The cost benefit study was not discussed at the public meeting (that is unfortunate, as it would have been interesting to hear because compliance costs will be high and many key stakeholders still question the benefits of the proposal). The question asked by the staff at the meeting was if the board members have any concerns regarding complexity that would hold up the issuance of the ED. The board’s view of complexity is more in regard to financial presentation and number of lease accounting models. My view of complexity is what preparers and users will have to do to comply with the new rules and what they will have to do to redo the accounting under the new rules to get the important information they need regarding leases.

The Breakdown of the Board Vote

Three board members voted that the project was too complex and did not meet user needs and they will dissent (their dissents will be published in the ED), but they will dissent for reasons that the leasing industry does not agree with. Two of the dissenters are analysts who want more payments like expected renewals (versus only bargain or compelling renewals), other variable payments like excess mileage and services included in leases (like bundle billed full service leases) included as minimum lease payments in the capitalization calculation. In my opinion the accounting rules should not violate sound accounting principles merely to give analysts a view of the financials that suits their narrow purposes — that is what disclosures are for. It seems the board wants to break from the time-tested accounting principles in FAS 5 as to what is a liability.

I would ask the question why doesn’t a company that buys a truck capitalize all the expected future repairs and maintenance so that the vehicle passes future inspections and complies with DOT regulations and performs as it wants/needs it to perform? Is there not a penalty incurred if the owned truck is not maintained? How about a company that buys a truck and enters into a service only contract — should those future service contract payments be capitalized? Why are leases being singled out to capitalize possible future payments or even contracted executory costs? The other dissenter is closer to our view in that he recognizes that the current proposal does not provide key information all in one place in the financial statements to users, but he proposes more complex disclosures to solve the flaws in the proposal.

Four board members support going ahead with the ED. Chairman Leslie Seidman is among them and continues to show the best understanding of the need for a two-lease model (finance lease versus “rental”/executory contract aka the former operating lease), although she still supports the ED. She said the board plans on intensive outreach during re-deliberations regarding the new ED. I welcome outreach, as we all know that most people/companies do not write comment letters (some don’t have the resources and some feel their letter would not make a difference in changing the FASB’s views). But expecting the need for extensive outreach and re-deliberations is a sad commentary on the new ED as one should expect less need for outreach and re-deliberation from a sound second ED. Two EDs in a project is not common.

Chairman Seidman’s term is up soon, so she will not be on the board as the project continues. I am concerned that we may not get a new chairman with the same great leadership qualities that Chairman Seidman provided throughout this long and difficult project. Seidman supports issuing the ED but says the ED approach is inconclusive as the board members failed to coalesce views. It is not universally thought that a one-lease model works. She does not agree with the classification line under the current proposal where real estate leases are treated differently than equipment leases. She will make comments as to her preferences in the ED.

The discussion at the meeting focused on simpler lease classification as one of the key measures of reducing complexity in lease accounting — only Seidman admitted that there was not universal acceptance that a one-lease model is correct. The board thinks that one-lease model will make lease accounting simple, but in simplifying something one must still test to see if the simpler model is still correct — that is, does it faithfully present the economic effects of lease transactions in the financial statements? Virtually all board members prefer a single-lease model but acknowledge they can’t find it (maybe because it does not exist).

The board members have been advised by many stakeholders that there are leases that transfer ownership rights (thus create a tangible asset and “true” debt) and those that merely transfer a right of use (the former operating leases that are executory contracts and create an intangible asset and non-debt liability that disappear in bankruptcy as their existence depends on continuing performance by both the lessor and lessee). The board members have been advised (but continue to ignore the advice) that the current GAAP classification tests are based on the legal analysis of a lease and accomplish the objective of classifying leases as either financings of the purchase of the underlying or merely a transfer of a right of use. As I see it, the only way to have a single lease model is to scope out finance leases (leases that transfer ownership rights), so that only executory contracts remain (leases that merely transfer a right of use, aka the former operating leases).

What the Board Failed to Discuss

The board did not talk about the costs and complexity regarding how lessees will have to rework the results of applying the proposed ED to get the info that they as preparers need and users of their financial statements need. The complexity discussion focused on how the financial statements would look. The board failed to talk about complex calculations to comply, the need to classify leases under existing GAAP for property tax purposes, the need to give users (lenders and credit analysts) information on leases broken down by finance lease and operating lease assets and liabilities for bankruptcy and credit analysis.

Conclusion Where Does the Project Go From Here?

The staff said the ED is in ballot form now, which means it is ready for the final vote to issue it. The board expects to issue it in mid- to late May.

It is also sad that the board has not read or maybe has not believed all the work the ELFA and the leasing industry have done on the legal view of leases that would allow it to easily draw the lines for classification. It is so frustrating to listen to the board members, knowing there are really only a few changes that they need to make to the ED to gain acceptance from most users and preparers, and it all could be accomplished if the board carried forward many of the concepts in FAS 13.
A 4-to-3 vote at the April meeting is not a vote of confidence, especially with the chairman voting to proceed but acknowledging the obvious need for re-deliberations. You should also know that the IASB is getting push back from the European Financial Reporting Advisory Group (EFRAG), a group that advises the European Union as to whether to accept or reject IASB accounting standards. EFRAG thinks that the proposed rules do not clearly define in the project’s scope what contacts are leases and what contracts are not leases. The EFRAG also said the IASB did not present sound justification to change the straight line P&L cost for leases that were formerly called operating leases. This is good news and adds to the swirling controversies surrounding the project as it stands.

I see the project dragging on and the boards getting more fatigued, which unfortunately leads to bad decisions just to get it over with. I also see the possibility that the project collapses without support from the European Union, as it has the power to reject it and it is the major customer of the IASB. There is also a possibility that the FASB splits with the IASB and goes with its own project, as I do not see how we avoid the SEC’s direction to capitalize operating leases. As I understand it, this will be the last attempt at a converged project. This is also good news as the FASB listens to U.S. constituents more that the IASB, and the FASB is less rigid in its thinking. Part of the reason for the duration of the lease project and its flaws has been trying to get the IASB and the FASB to agree.

Although I say there is hope that the direction of the project will change for the better, it will only come to pass if you all write comment letters. The number of letters makes a difference in getting the board’s attention and the quality of the letters can influence it to change the direction.

Bill Bosco can be reached at [email protected], www.leasing-101.com or 914-522-3233.

 

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