"We need to be ready to make a decision"

The FASB & IASB had separate "education sessions" on June 6, to review the materials the staffs have prepared for next week's joint meeting regarding the new lease accounting standard (and other projects). The FASB session is available here; the discussion on leases starts at about 1 hour, 30 minutes in from the beginning. You can view the IASB session by clicking on the "Register" link on this page. The discussion won't make a lot of sense without having the agenda papers available to look at; those are available here (right-click to download the zip file).

The staffs have, as directed by the boards last month, prepared three possible approaches for expense recognition:

1. The current plan: All leases are treated using current finance lease accounting.
2. What was called "Approach D" last month: level expense recognition, with the asset and liability linked throughout the life of the lease (if rent payments are equal throughout the lease life, asset and liability will be equal at all times).
3. A combination of the two approaches, with the necessity to decide which leases need which treatment.

More information was provided about Approach D, now Approach 2. It hadn't been clear last month how to account for leases where the rents change over the life. I speculated that there might be a deferred rent liability, as with current operating lease accounting. Now the staff has clarified that such adjustment should be recognized in the asset, rather than in a separate account. Other adjustments to the asset could also result in assets and liabilities being unequal, such as initial direct costs (added) or impairments (subtracted).

If Approach 3 is desired, then the boards need to decide where to "draw the line" to determine which leases get which treatment. Four options were presented:

1. Finance lease accounting when the lease transfers substantially all the risks and rewards of ownership (the language used currently in IAS 17, which is also the concept behind FAS 13; the determination, however, would be made using IAS 17 principles, rather than FAS 13's "bright lines" of 75% and 90%).
2. Finance lease accounting when the ROU asset represents the acquisition of a more than insignificant portion of the underlying asset.
3. Determination based on the nature of the underlying asset:
   
   • Property leases would use Approach 2 (straight line) unless the lease term is for the major part of the economic life of the underlying asset or the present value of the rent accounts for substantially all of the asset's fair value;
   • Equipment leases would use Approach 1 (financing) unless the lease term is an insignificant portion of the economic life of the underlying asset or the present value of the rents is insignificant relative to the asset's fair value. 
4. Determination based on the lessee’s business purpose for entering into the lease arrangement.

Most of the FASB board members (at least 5 of the 7) felt that it was appropriate to draw a line, considering that there are different purposes and intentions for different types of leasing transactions, and that it is appropriate to recognize those. Outreach indicated that virtually all property lessees see their transactions as generally not having a financing component; they see it as simply gaining use of an asset for a period of time. Equipment lessees are more split; some deny a financing component, but major aircraft lessees admit that that's part of the transaction.

Option 4 seemed to have the least support; while it seemed superficially to allow preparers to account for their actual intentions, there was substantial concern of gaming the system and a lack of comparability between different companies. Options 2 & 3 were seen as effectively the same, simply stated differently; Option 2 might be seen as more principles-based, while Option 3 is perhaps easier to put into practice. Some thought that Option 1 would be the simplest to apply, since everyone is familiar with the concept already; however, that would result in most aircraft leases getting straight-line rather than finance accounting, which was troubling. (Aircraft operating lease accounting is a poster child for the need for a new lease accounting standard.)

One board member indicated that he thought in-substance purchases were scoped out of the new lease standard. That's news to me; it had been discussed at one point, but I thought that was long since discarded. I don't see any support for that in the FASB's summary of tentative decisions to date.

During the outreach, most users of financial statements (i.e., financial analysts and investors) expressed a preference for a single approach to lessee accounting, but generally the more important issue to them was getting everything on the balance sheet. It was felt that proper disclosure could enable users who prefer to see leases a different way to make the adjustments they need.

There was some discussion regarding the implications for lessor accounting. Some board members consider symmetry important. Others consider the different business models and purposes on the two sides of the transactions sufficient that symmetry doesn't matter; at least one suggested that no change at all to lessor accounting from current practice is necessary.

The boards are concerned that their decision not seem arbitrary, recognizing that some people will be unhappy with whatever decision they make. They want to be able to defend it on a theoretical, not just practical, basis.

At the end of the session, a FASB board member asked the staff for what preferences had been expressed at the IASB education session held earlier in the day. It was reported that a majority of the IASB seems to have a first preference for Approach 1, but also that the strength of preference for that over Approach 3 would depend on where a line was to be drawn. So we have a difference of opinion between the boards; we know that they want very strongly to release a unified standard, so we'll have to see how that gets resolved.

To wrap up, though, the comment was, "We need to be ready to make a decision." The staff said a similar sentiment was expressed by the IASB. They've scheduled 5-1/2 hours of discussion for Wednesday & Thursday, June 13 & 14.

The staff expects this meeting to include the last substantive decisions on the new standard to be presented in the revised exposure draft (RED). They plan to follow up in July with wrap-up decisions, such as the comment period for the RED and interim disclosures, plus any decisions that may need to follow on from June decisions (such as adjusting disclosures if the approach to lessee accounting changes). After that, they would be ready to draft the RED and release it later in the year. The FASB Current Technical Plan is now reporting that the RED is expected to be released in Q4 2012 (that's a recent development; just a few weeks ago, it was simply "second half of 2012").