Opposition to the Revised Exposure Draft (RED) of the lease accounting standard is starting to build. Asset Finance International is reporting that the FASB's Investors Technical Advisory Committee (ITAC), at a meeting on July 24, unanimously disagreed with the boards' new approach to lease accounting, though the committee split three ways on their preferred methodology (capitalize all leases using the current methodology, use the new SLE (straight line expense) methodology for all leases, or keep current accounting but with more disclosure). "At the meeting FASB chairman Leslie Seidman acknowledged: 'I can hear that none of you think that we got it right.' "
Bill Bosco, a well-known leasing consultant and member of the boards' Leases Working Group advisory group, sent the boards a letter disagreeing with the proposals as well, though for different reasons. He is particularly concerned with the disparate treatment of equipment and real estate leases.
ELFA, the primary trade organization for equipment lessors in the U.S., has also weighed in with an unsolicited comment letter to the boards. They had been broadly in favor of the idea of revising the lease accounting standard, particularly to put leases on the lessee's balance sheet, but now are considering withdrawing support of the proposed standard, primarily because of the standard's presumption that virtually all equipment leases are essentially purchases (and thus merit finance lease accounting).
The boards are meeting this week to discuss sale/leaseback details (in particular, how to coordinate lease accounting with revenue recognition accounting to make them as consistent as possible), as well as handling impairment of SLE leases, whether to allow another systematic basis other than straight line, whether finance vs. SLE classification is subject to revision after commencement, and how to handle classification of a sublease.
The documents posted for this week's meeting indicate that the delivery date for the RED has been pushed back to first quarter 2013. It was previously expected in November.
Showing posts with label exposure draft. Show all posts
Showing posts with label exposure draft. Show all posts
Monday, September 17, 2012
Thursday, July 19, 2012
It's a wrap, finally
On July 17, the IASB & FASB met to make their last decisions before releasing a revised exposure draft (RED) for the new lease accounting standard. The following decisions were reached (according to meeting notes posted at IASPlus):
Several board members expressed interest in additional disclosure of cash paid for leases that would distinguish I&A, SLE, short-term leases, and variable lease payments. The staffs will review this and potentially provide a future staff paper for board action.
Reconciliation of the opening & closing balances on liabilities will be separated between I&A and SLE leases, because the liabilities themselves are being reported separately.
On the asset side, the boards disagreed. The FASB chose not to require a reconciliation at all. The IASB chose to require separate reconciliations for I&A and SLE leases.
The staff recommended a disclosure table for lease expenses, including amortization and interest for I&A leases, variable lease payments, short-term lease payments, SLE, principal & interest on I&A leases, and SLE cash paid. The boards thought this was overload, and decided only to require disclosure of variable lease payments.
Next steps
This isn't quite the end of the decision-making process. The FASB will be meeting next week to discuss a few FASB-only issues.
With these decisions complete, the staffs will now assemble all the "tentative" decisions into the form of an exposure draft. The draft will then be circulated to the boards to make sure it accurately reflects the decisions reached, then released to the public. The expectation is that it will be released during Q4, probably in November. There will be a 120-day comment period, which thus would be expected to end in March 2013 (though that might get tweaked because it falls in the middle of annual reporting for companies on a calendar year basis). Once that's complete, figure a month or so for the staffs to compile the results of the comments, so probably in May the boards will start their review and redeliberations. One can expect that there is still going to be some controversy over the decisions, so redeliberations will probably take a few months. At the meeting, two members of each board indicated an intention to dissent from the exposure draft, with an additional member of each board considering dissent; concerns included complexity and cost/benefit, exclusion of variable lease payments, insufficient disclosure, maintaining two types of leases when unified accounting was a key objective originally, and inconsistency between lessor accounting and the concurrent revenue recognition project.
If there are no significant changes, it may be possible to get the final standard approved in 2013, but it would seem to me it's not likely to be out until late in 2013. Given that, it seems almost certain that implementation would be required for 2016 (with restatement of prior years going back two years for most U.S. firms). That makes a total of just under 10 years from the time the project was announced in July 2006 to final implementation; the original plan was to have the final standard released in 2009, with implementation in 2011.... In a webinar today (July 19), the staff indicated that they expect that earlier implementation will be permitted, while non-public entities may get additional time for implementation.
Lessee accounting
Statement of financial position (balance sheet)
Assets and liabilities for the two types of leases (finance, also called "interest and amortization" or I&A, and straight line expense (SLE)) will be reported separately, either on the SFP itself or in disclosure notes. Assets are to be presented based on the type of underlying asset.Statement of cash flows
Cash paid for SLE leases will be reported as an operating activity. It was previously decided that cash paid for I&A leases will be reported as a financing activity for the principal portion, and in accordance with applicable IFRS or US GAAP standards for interest (IFRS permits it as either operating or financing, while US GAAP puts it in financing).Several board members expressed interest in additional disclosure of cash paid for leases that would distinguish I&A, SLE, short-term leases, and variable lease payments. The staffs will review this and potentially provide a future staff paper for board action.
Disclosure
The maturity analysis (future rent commitments by year for at least 5 years, then combined to expiration) will not be separated between I&A and SLE leases. This was justified by the fact that the liability is calculated the same way for both types of leases. The FASB had previously decided that commitments for services and other non-lease components need to be disclosed; the FASB decided that this disclosure will also be a single report for all leases, not separated between I&A and SLE.Reconciliation of the opening & closing balances on liabilities will be separated between I&A and SLE leases, because the liabilities themselves are being reported separately.
On the asset side, the boards disagreed. The FASB chose not to require a reconciliation at all. The IASB chose to require separate reconciliations for I&A and SLE leases.
The staff recommended a disclosure table for lease expenses, including amortization and interest for I&A leases, variable lease payments, short-term lease payments, SLE, principal & interest on I&A leases, and SLE cash paid. The boards thought this was overload, and decided only to require disclosure of variable lease payments.
Transition: SLE lease asset
The boards previously changed their approach for transitioning existing operating leases to the new regime: in the original exposure draft, they planned to make the asset and liability equal at the date of initial application, but because that would have front-loaded expenses for all leases, they decided to switch to a "modified retrospective" approach which results in an asset value largely similar to what one would have restating from inception (see my discussion of the details here). With SLE leases, however, front-loading isn't an issue, so the boards approved using the original methodology with the asset and liability equal at the date of initial application (though with an option for a fully retrospective application, which is also permitted for I&A leases). If there's a deferred rent liability/asset due to unequal lease payments, that is applied to the asset.Lessor accounting
The boards decided that when a lease is terminated early and the lessor takes back the asset, the remaining receivable and the residual should be combined and set up as a re-recognized asset. No gain or loss would be reported on the transaction (though impairment might separately be recognized, if the remaining receivable that's being reclassified is less than the fair value of the leased portion of the asset plus any penalty payments made).Interim disclosure
For both lessees and lessors, the boards decided that generally interim disclosures (that is, disclosures required during interim reporting periods, such as quarterly reports for US companies) should be handled consistently with existing standards (IAS 34, US GAAP Topic 270, and SEC Regulation S-X, Rule 10-01). However, an additional disclosure for lessors to detail components of lease income was approved. The FASB approved the proposal as presented by the staffs; the IASB preferred to permit a single lease income number in some cases. This leaves a rare non-convergent situation to be dealt with in the post-RED redeliberations. Next steps
This isn't quite the end of the decision-making process. The FASB will be meeting next week to discuss a few FASB-only issues. With these decisions complete, the staffs will now assemble all the "tentative" decisions into the form of an exposure draft. The draft will then be circulated to the boards to make sure it accurately reflects the decisions reached, then released to the public. The expectation is that it will be released during Q4, probably in November. There will be a 120-day comment period, which thus would be expected to end in March 2013 (though that might get tweaked because it falls in the middle of annual reporting for companies on a calendar year basis). Once that's complete, figure a month or so for the staffs to compile the results of the comments, so probably in May the boards will start their review and redeliberations. One can expect that there is still going to be some controversy over the decisions, so redeliberations will probably take a few months. At the meeting, two members of each board indicated an intention to dissent from the exposure draft, with an additional member of each board considering dissent; concerns included complexity and cost/benefit, exclusion of variable lease payments, insufficient disclosure, maintaining two types of leases when unified accounting was a key objective originally, and inconsistency between lessor accounting and the concurrent revenue recognition project.
If there are no significant changes, it may be possible to get the final standard approved in 2013, but it would seem to me it's not likely to be out until late in 2013. Given that, it seems almost certain that implementation would be required for 2016 (with restatement of prior years going back two years for most U.S. firms). That makes a total of just under 10 years from the time the project was announced in July 2006 to final implementation; the original plan was to have the final standard released in 2009, with implementation in 2011.... In a webinar today (July 19), the staff indicated that they expect that earlier implementation will be permitted, while non-public entities may get additional time for implementation.
Thursday, June 14, 2012
Two expense profiles
At the joint meeting of the IASB & FASB yesterday (June 13), the boards came to an agreement on the expense recognition patterns for lessee leases to be presented in the Revised Exposure Draft (RED). (My thanks to Asset Finance International for their summary of the board meeting.) If you're looking at the meeting papers prepared by the staff (available here), the choice made was for Approach 3, meaning that some leases will be accounted for using current finance/capital lease accounting (recognizing interest and depreciation expense, with the effect that expenses are higher at the beginning of the lease), while others will be accounted for with a single lease expense item which is recognized straight line over the life of the lease. If the rent payments are equal over the life of the lease, the asset and liability balances will be equal at any date. If they are unequal, the adjustment required to balance cash rent vs. accrual expense (what is shown under current operating lease accounting as a deferred rent liability) will be taken to the asset. The asset will also be adjusted for any initial direct costs or impairments, both of which are to be recognized over the life of the lease (or remaining life, for an impairment).
The second decision was where to draw the line between the two types of expense recognition. The boards opted for Option 3 (as described in agenda paper 3D/237):
(a) Leases of property (defined as land or a building – or part of a building – or both) should be accounted for using a straight-line presentation in the income statement ... unless:
(i) The lease term is for the major part of the economic life of the underlying asset; or
(ii) The present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset.
(b) Leases of assets other than property should be accounted for under Approach 1 [finance accounting] ... unless:
(i) The lease term is an insignificant portion of the economic life of the underlying asset;
(ii) The present value of the fixed lease payments is insignificant relative to the fair value of the underlying asset.
The boards' push for convergence was in evidence in the voting. A solid majority of the IASB preferred a single methodology for all leases, using finance lease accounting. However, members of the FASB very strongly felt that straight line expensing was a necessary part of the standard, and the IASB agreed in the interest of having a common standard.
The implications are that virtually all equipment (except leases of 12 months or less, which have previously been excluded from the standard and will be treated like current operating leases) will use finance accounting, while the vast majority of property leases will use straight line accounting. Only when a property lease is for nearly all of an asset's useful life (or there is an ownership transfer or bargain purchase option) will finance accounting be used. We'll have to see how this sorts out in practice, but this probably means that a lease of a building for less than 30 or 40 years will use straight line unless there are very special circumstances.
At this point, I wouldn't expect an effective date before 2016, to allow companies time to update their systems and gather any needed information. However, the requirement to restate prior years remains, so U.S. companies will generally need to recalculate 2014 & 2015 when they first apply the standard in 2016. If early implementation is permitted, the recalculation period would move forward commensurately. In other words, 2016 isn't that far away.
The second decision was where to draw the line between the two types of expense recognition. The boards opted for Option 3 (as described in agenda paper 3D/237):
(a) Leases of property (defined as land or a building – or part of a building – or both) should be accounted for using a straight-line presentation in the income statement ... unless:
(i) The lease term is for the major part of the economic life of the underlying asset; or
(ii) The present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset.
(b) Leases of assets other than property should be accounted for under Approach 1 [finance accounting] ... unless:
(i) The lease term is an insignificant portion of the economic life of the underlying asset;
(ii) The present value of the fixed lease payments is insignificant relative to the fair value of the underlying asset.
The boards' push for convergence was in evidence in the voting. A solid majority of the IASB preferred a single methodology for all leases, using finance lease accounting. However, members of the FASB very strongly felt that straight line expensing was a necessary part of the standard, and the IASB agreed in the interest of having a common standard.
The implications are that virtually all equipment (except leases of 12 months or less, which have previously been excluded from the standard and will be treated like current operating leases) will use finance accounting, while the vast majority of property leases will use straight line accounting. Only when a property lease is for nearly all of an asset's useful life (or there is an ownership transfer or bargain purchase option) will finance accounting be used. We'll have to see how this sorts out in practice, but this probably means that a lease of a building for less than 30 or 40 years will use straight line unless there are very special circumstances.
Lessor accounting
Having made that decision, the boards discussed the implications for lessors. Since they previously decided that lessors of "investment property" could use operating lease accounting, and this would cover virtually all property lessors, the focus was on equipment lessors. The boards decided that they would use accounting more or less symmetrical with lessee accounting, so the "receivable and residual" model will apply to equipment leases unless the lease has an "insignificant" term or receivable. This is similar to current capital lessor accounting, but with the benefit to lessors that they are permitted to recognize a portion of profit at inception (proportional to the value of the receivable compared to the residual), whereas currently profit is recognized over the life of the lease.Next steps
There will be some wrap-up decisions to make at the July joint boards meeting, related to the RED comment period, transition, and disclosure adjustments. After that, the staff will prepare the RED, with the expectation that it will be released in Q4 2012. (If no further hitches come up, early in the quarter would seem likely.) With an expected 4-month comment period, then time to redeliberate based on comments received, a mid-year 2013 release date of the new standard seems possible, unless there's strong pushback. However, the boards seem to have met the biggest objections, so I think any changes this time around are likely to be modest (tweaks of wording, adjustments of disclosures, etc.), not the wholesale rewrite that we got between the original ED and the RED.At this point, I wouldn't expect an effective date before 2016, to allow companies time to update their systems and gather any needed information. However, the requirement to restate prior years remains, so U.S. companies will generally need to recalculate 2014 & 2015 when they first apply the standard in 2016. If early implementation is permitted, the recalculation period would move forward commensurately. In other words, 2016 isn't that far away.
EZ13
Here at Financial Computer Systems, we're finishing up the latest update of EZ13, which will be released this summer. We won't have the new level expense capital methodology in that version, but will be working on it later this year. We'll have it in place, including transitions from current accounting, long before implementation is required. We do right now provide for pro forma capitalizing operating leases according to current capitalization rules, so you can see what your balance sheet exposure is under the RED.Thursday, June 7, 2012
"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:
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:
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").
The staffs have, as directed by the boards last month, prepared three possible approaches for expense recognition:
- The current plan: All leases are treated using current finance lease accounting.
- 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).
- A combination of the two approaches, with the necessity to decide which leases need which treatment.
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:
- 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%).
- Finance lease accounting when the ROU asset represents the acquisition of a more than insignificant portion of the underlying asset.
- 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.
- Determination based on the lessee’s business purpose for entering into the lease arrangement.
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").
Thursday, March 15, 2012
Into the second half of 2012
The FASB recently updated their project timeline for the new lease accounting standard, and they've now officially pushed back the date for release of the revised exposure draft (RED) to the second half of 2012. This is at least a 9-month delay from the original plan: last July they expected to finish the redeliberations in September 2011 with the RED to come shortly thereafter. But, of course, the whole project has been a story of delays; it's mind-boggling to think that when they announced the project in 2006, they expected to be finished in 2008.
Thursday, February 23, 2012
Schedule for wrapping up the redeliberations
The IASB has posted on its web site the agenda papers for next week's combined IASB/FASB board meeting, which will include discussion of lease accounting. One of the agenda papers details the schedule from here out:
February boards meeting: last substantive discussions
March boards meeting: "sweep issues" such as comment period and any interim disclosures
Following: Second Exposure Draft is drafted. They don't say anything more than "later in 2012" for when it will be released, though the IASB Work Plan page indicates Q2 2012 (the equivalent FASB Project Updates page says the same thing).
February boards meeting: last substantive discussions
March boards meeting: "sweep issues" such as comment period and any interim disclosures
Following: Second Exposure Draft is drafted. They don't say anything more than "later in 2012" for when it will be released, though the IASB Work Plan page indicates Q2 2012 (the equivalent FASB Project Updates page says the same thing).
Tuesday, October 25, 2011
This month's boards meeting
On Oct. 19, the FASB & IASB again met to discuss the new lease accounting standard. In a marathon session (scheduled for 5 hours), they reached a number of decisions in several areas. (Note: in the discussion below, and elsewhere in discussions about this standard, "effective date" is the date companies must start reporting under the new standard, while "date of initial application" is the date, normally two years earlier for U.S. companies, as of which leases must be treated as capital once the new standard takes effect, due to the requirement to restate years shown as comparables in the annual report.)
Lessee transition
Lessee transition
- All existing capital leases will be carried over with no changes required. Previously, they had planned to require restatement of capital leases with variable payments or renewal options that would be treated differently under the new standard. They decided the benefit wasn't worth the cost, because in most cases the differences would be small (particularly given recent decisions to reduce recognition of variable payments and options).
- The incremental borrowing rate to use for operating leases to be capitalized will be a single company-wide rate, not based on the individual characteristics of each transitioning lease.
- Operating leases can be recalculated using either a "full" or a "modified" retrospective methodology. The same methodology must be chosen for all leases. Full means going back to lease inception and calculating the lease as capital. Modified is different from what was in the original Exposure Draft; I described it last month. They have clarified that the difference between asset and liability generated by this method is to be booked to retained earnings (no P&L impact).
- The simplifications ("reliefs") mentioned last month were all confirmed: leases that terminate before the effective date of the new standard won't have to be restated, even if they start after the date of initial application; initial direct costs are excluded during the same period; and preparers may use hindsight to set up the leases.
- Capital leases other than leveraged leases can be carried over with no adjustments.
- Leveraged lease accounting is eliminated. Such leases will have to be restated.
- Current operating leases will have a receivable and residual set up using the present value of the rents and expected residual value at date of initial application, the interest rate being the rate charged in the lease as of lease inception; the underlying asset is derecognized. Lessors also have the option of full retrospective application.
- A proposal to report receivables held for sale at fair value was rejected. While this would superficially be consistent with IFRS 9 and the FASB's Accounting for Financial Instruments project, it was felt that it added complexity, was inconsistent with the rest of the leasing standard, offered opportunities for structuring, and would add more variability in profit and loss. Instead, any gain or loss would be recognized when a sale of the receivable is completed.
- If the rate a lessor charges a lessee assumes "reasonably assured" variable lease payments will be made, the residual asset (which by default contains the value of those payments, since the value is not in the receivable) will be adjusted by recognizing an adjustment to the residual. The adjustment is the variable lease payment divided by the fair value of the underlying asset, times its carrying amount.
- Investment property is excluded from the lease standard scope. This keeps those properties under IAS 40 for companies using IFRS. The FASB is working on a project to create the same standard for the U.S. (which presumably will be complete by the time the lease standard takes effect).
- Profit on the residual will not be recognized until the asset is sold or re-leased.
- The residual is initially booked at the present value of the residual. The value is accreted, with interest income recognized for the accretion, using the same interest rate as for the receivable.
Friday, October 21, 2011
Exposure Draft delayed to 2012
The FASB & IASB have updated their project schedules to indicate that the revised exposure draft (RED) will be released in Q1 2012. That's another delay of three months from what was expected when they announced in July that a RED would be released. The Equipment Lease and Financing Association is reporting that the comment period will be a full 120 days; there had been speculation that the comment period might be shorter the second time around. That means that the comment period won't end until near the end of Q2. With time for redeliberation, that suggests that the final standard won't be out until late in 2012.
It's yet the latest delay in an oft-delayed project. When originally announced back in 2006, the boards expected to be done in 2009. The latest delay could affect the implementation date; speculation recently has focused on 2015 as the implementation date, but given the planned requirement to restate the prior two years of comparable financials, that means there could be just weeks between the release of the standard and when (1/1/2013) leases will effectively need to be reported under it. During those two years until actual implementation, bookings will be done under current standards, but companies will need to make sure they keep complete information on their leases to enable recreating their accounting under the new methodology. Of course, with the active consideration of full retrospective accounting (though probably not to be required, just optional), it would be good to be keeping information right now on any leases that you expect to remain active into 2015. (It is expected that leases that expire before implementation won't need to be recalculated.)
The boards held a lengthy meeting this week on leases, but I don't have time to review the 5 hours of recordings, and my normal sources haven't yet posted summaries of the events.
It's yet the latest delay in an oft-delayed project. When originally announced back in 2006, the boards expected to be done in 2009. The latest delay could affect the implementation date; speculation recently has focused on 2015 as the implementation date, but given the planned requirement to restate the prior two years of comparable financials, that means there could be just weeks between the release of the standard and when (1/1/2013) leases will effectively need to be reported under it. During those two years until actual implementation, bookings will be done under current standards, but companies will need to make sure they keep complete information on their leases to enable recreating their accounting under the new methodology. Of course, with the active consideration of full retrospective accounting (though probably not to be required, just optional), it would be good to be keeping information right now on any leases that you expect to remain active into 2015. (It is expected that leases that expire before implementation won't need to be recalculated.)
The boards held a lengthy meeting this week on leases, but I don't have time to review the 5 hours of recordings, and my normal sources haven't yet posted summaries of the events.
Monday, September 26, 2011
Boards get back to work, timeline slips further?
When the FASB and IASB decided in July to prepare a second Exposure Draft for the proposed new lease accounting standard, they expected to finish all the loose ends in September and release the RED (Revised Exposure Draft) soon after. Oops, here we go again. The whole history of this new standard has been one of delays: when the project was announced in 2006, it was supposed to be completed in 2009.
Even before the meeting, the boards realized they weren't going to be able to do everything this month. (There was no joint meeting in August; it's not clear whether the month off was considered in their July timeline.) But the agenda for this month included the plan to bring "all remaining redeliberation issues to the boards in the October joint board meeting." Now Asset Finance International is reporting that the boards want more time to redeliberate the remaining issues, and that it might take until next February to issue the RED, with a final standard of course being several months after that (to allow time for public comment, then redeliberation). It's not clear what their basis is for this projection; the FASB's Technical Plan still has a Q4 estimated publication date for the RED (with the notation that this was updated 9/23/11), though it doesn't list any date for the final standard. However, some decisions due this month were either completely deferred or have loose ends dangling.
Decisions made at the Sep. 19 and Sep. 21 joint board meetings:
Scope - inventory
Some people had suggested that the right-of-use asset for a lease could in some cases also meet the definition of inventory, and would be subject to potentially conflicting standards. The boards decided that the situation doesn't really seem possible, and therefore there's no need to prepare guidance to distinguish.
Financial asset guidance application to lessor's right to receive payments
A major concern of the boards is keeping accounting consistent between different types of transactions. The lessor's right to receive rent payments could be considered a financial asset. The boards decided that such standards (specifically, IFRS 9, IAS 39, and US GAAP Topic 825) should not apply to regular measurement of the receivable, but would apply to impairment. This also confirms the previous decision that fair value measurement/revision is not permitted for the receivable.
Lessor impairment
For the lessor receivable, the impairment standard for the applicable GAAP environment (Topic 310 for U.S. preparers, IAS 39 for IFRS) applies. For the residual asset, IAS 36 and Topic 360 apply; for US preparers, this indicates impairment is handled in a manner congruent with property, plant, & equipment, rather than intangibles. This is basically the same as lessee treatment.
Lessor balance sheet presentation
Lessors will be required to report all their leased assets, both receivables and residuals, as a "Lease Assets" line in PP&E. Lessors may choose whether to separate the receivables and residuals in the balance sheet, or footnote the detail. Sublease assets should be shown separately.
Subsequent adjustments of variable rents, lessor
The recalculation of variable rent payments due to changes in a rate or index (such as changes in LIBOR or the CPI) can result in a gain or loss. That is to be recognized immediately in profit & loss, rather than being rolled into the asset (as is largely the case for lessees).
Lessor accounting for residual value guarantees
The boards agreed that a residual value guarantee would not be separately recognized (whether provided by the lessee or a third party). It would be taken into account in determining the value of the residual asset, including testing for impairment.
Lessor cash flow statement
Lease payments are classified as operating (not investing) activities. An exception was made, however, for cash flows related to securitized receivables, which would be accounted for under existing guidance.
Transition, lessees
The ED called for lessees to capitalize the remaining rents on all operating leases, with an equal asset and liability set up at the date of initial application. (Note: the effective date is when the standard takes effect; the date of initial application is the date, two years prior for most US companies, as of which leases have to be treated as capital for comparison purposes.) The problem with this for the income statement is that because it treats all (formerly operating) leases as new on the date of initial application, all of those leases will be at the beginning of the interest amortization curve, when the interest recognized is highest. This means that all lessees would face considerably higher expenses than rent payment as of initial application (with expenses dropping over time, as the principal is paid down and interest correspondingly declines).
It was recognized that this results in artificial swings in expenses. For a lessee with a mix of leases starting and ending roughly evenly from year to year, the overall lease expense profile should be relatively flat, even as each individual lease shows more expense in the early years and less in the later years.
In looking for ways to mitigate this, the staffs presented to the boards two alternatives:
1) full retrospective approach
2) modified retrospective approach (distinguished from the ED's "simplified retrospective approach")
Full retrospective is seen as theoretically preferable. However, it is recognized that for some preparers, this may be difficult to execute. One particularly challenging scenario is leases that have been acquired in a business combination, where the original information for the lease may no longer be available. Long-lived leases may have similar issues. Therefore, the staffs proposed a modified methodology, where the liability would be calculated as the ED specified (present value of remaining rents, using the incremental borrowing rate at the date of initial application), and the asset would use the same calculation back to inception, then recognize the fractional amount of the lease term remaining.
Transition example (provided in Agenda Paper 2G/203):
(Please note: I calculate slightly different present values, using an HP12C or Excel, than the agenda paper presents. In the example below, I list first their calculation, then my calculation in parentheses with an asterisk.)
10 year lease, payments of 1000 CU (generic Currency Units) yearly in arrears
interest rate of 5.7%
date of initial application: beginning of 5th year (i.e., 6 years remaining)
present value of rents at inception: 7,472 (*7,466)
present value of rents at application: 4,967 (*4,964)
asset at application: 7,472 * 6 / 10 = 4,483 (*4,479)
The difference between the asset and obligation would be taken as a "cumulative catch-up adjustment." I believe this would be booked directly to retained earnings, not recognized in profit and loss. Because of the way the interest method works, every lease (except possibly a lease that has lower rents at the end of its life) will book a charge to retained earnings to be set up, so the cost of reducing the impact to the income statement is increasing the impact on the balance sheet (debt/equity ratios will balloon even further). Pick your poison.
The boards, however, didn't pick their poison. They deferred the decision to next month, asking to combine the decision with transition rules for lessors and subleases.
The staffs also suggested a few simplifications: 1) leases that terminate between the date of initial application and the effective date would not have to be restated; 2) exclude initial direct costs for leases that start before the effective date; 3) allow use of hindsight in estimating such lease characteristics as variable lease payments, renewals, and impairment. These will be considered as part of the entire transition package.
This kind of continued change is why no software publisher can claim to be compliant with the new lease accounting standard yet. It's a moving target. But we'll update EZ13 once decisions are finalized; in the meantime, EZ13 allows you to treat operating leases as capital, either from inception or as of a specified cutover date as specified in the original ED, to estimate what your exposure is.
Even before the meeting, the boards realized they weren't going to be able to do everything this month. (There was no joint meeting in August; it's not clear whether the month off was considered in their July timeline.) But the agenda for this month included the plan to bring "all remaining redeliberation issues to the boards in the October joint board meeting." Now Asset Finance International is reporting that the boards want more time to redeliberate the remaining issues, and that it might take until next February to issue the RED, with a final standard of course being several months after that (to allow time for public comment, then redeliberation). It's not clear what their basis is for this projection; the FASB's Technical Plan still has a Q4 estimated publication date for the RED (with the notation that this was updated 9/23/11), though it doesn't list any date for the final standard. However, some decisions due this month were either completely deferred or have loose ends dangling.
Decisions made at the Sep. 19 and Sep. 21 joint board meetings:
Scope - inventory
Some people had suggested that the right-of-use asset for a lease could in some cases also meet the definition of inventory, and would be subject to potentially conflicting standards. The boards decided that the situation doesn't really seem possible, and therefore there's no need to prepare guidance to distinguish.
Financial asset guidance application to lessor's right to receive payments
A major concern of the boards is keeping accounting consistent between different types of transactions. The lessor's right to receive rent payments could be considered a financial asset. The boards decided that such standards (specifically, IFRS 9, IAS 39, and US GAAP Topic 825) should not apply to regular measurement of the receivable, but would apply to impairment. This also confirms the previous decision that fair value measurement/revision is not permitted for the receivable.
Lessor impairment
For the lessor receivable, the impairment standard for the applicable GAAP environment (Topic 310 for U.S. preparers, IAS 39 for IFRS) applies. For the residual asset, IAS 36 and Topic 360 apply; for US preparers, this indicates impairment is handled in a manner congruent with property, plant, & equipment, rather than intangibles. This is basically the same as lessee treatment.
Lessor balance sheet presentation
Lessors will be required to report all their leased assets, both receivables and residuals, as a "Lease Assets" line in PP&E. Lessors may choose whether to separate the receivables and residuals in the balance sheet, or footnote the detail. Sublease assets should be shown separately.
Subsequent adjustments of variable rents, lessor
The recalculation of variable rent payments due to changes in a rate or index (such as changes in LIBOR or the CPI) can result in a gain or loss. That is to be recognized immediately in profit & loss, rather than being rolled into the asset (as is largely the case for lessees).
Lessor accounting for residual value guarantees
The boards agreed that a residual value guarantee would not be separately recognized (whether provided by the lessee or a third party). It would be taken into account in determining the value of the residual asset, including testing for impairment.
Lessor cash flow statement
Lease payments are classified as operating (not investing) activities. An exception was made, however, for cash flows related to securitized receivables, which would be accounted for under existing guidance.
Transition, lessees
The ED called for lessees to capitalize the remaining rents on all operating leases, with an equal asset and liability set up at the date of initial application. (Note: the effective date is when the standard takes effect; the date of initial application is the date, two years prior for most US companies, as of which leases have to be treated as capital for comparison purposes.) The problem with this for the income statement is that because it treats all (formerly operating) leases as new on the date of initial application, all of those leases will be at the beginning of the interest amortization curve, when the interest recognized is highest. This means that all lessees would face considerably higher expenses than rent payment as of initial application (with expenses dropping over time, as the principal is paid down and interest correspondingly declines).
It was recognized that this results in artificial swings in expenses. For a lessee with a mix of leases starting and ending roughly evenly from year to year, the overall lease expense profile should be relatively flat, even as each individual lease shows more expense in the early years and less in the later years.
In looking for ways to mitigate this, the staffs presented to the boards two alternatives:
1) full retrospective approach
2) modified retrospective approach (distinguished from the ED's "simplified retrospective approach")
Full retrospective is seen as theoretically preferable. However, it is recognized that for some preparers, this may be difficult to execute. One particularly challenging scenario is leases that have been acquired in a business combination, where the original information for the lease may no longer be available. Long-lived leases may have similar issues. Therefore, the staffs proposed a modified methodology, where the liability would be calculated as the ED specified (present value of remaining rents, using the incremental borrowing rate at the date of initial application), and the asset would use the same calculation back to inception, then recognize the fractional amount of the lease term remaining.
Transition example (provided in Agenda Paper 2G/203):
(Please note: I calculate slightly different present values, using an HP12C or Excel, than the agenda paper presents. In the example below, I list first their calculation, then my calculation in parentheses with an asterisk.)
10 year lease, payments of 1000 CU (generic Currency Units) yearly in arrears
interest rate of 5.7%
date of initial application: beginning of 5th year (i.e., 6 years remaining)
present value of rents at inception: 7,472 (*7,466)
present value of rents at application: 4,967 (*4,964)
asset at application: 7,472 * 6 / 10 = 4,483 (*4,479)
The difference between the asset and obligation would be taken as a "cumulative catch-up adjustment." I believe this would be booked directly to retained earnings, not recognized in profit and loss. Because of the way the interest method works, every lease (except possibly a lease that has lower rents at the end of its life) will book a charge to retained earnings to be set up, so the cost of reducing the impact to the income statement is increasing the impact on the balance sheet (debt/equity ratios will balloon even further). Pick your poison.
The boards, however, didn't pick their poison. They deferred the decision to next month, asking to combine the decision with transition rules for lessors and subleases.
The staffs also suggested a few simplifications: 1) leases that terminate between the date of initial application and the effective date would not have to be restated; 2) exclude initial direct costs for leases that start before the effective date; 3) allow use of hindsight in estimating such lease characteristics as variable lease payments, renewals, and impairment. These will be considered as part of the entire transition package.
This kind of continued change is why no software publisher can claim to be compliant with the new lease accounting standard yet. It's a moving target. But we'll update EZ13 once decisions are finalized; in the meantime, EZ13 allows you to treat operating leases as capital, either from inception or as of a specified cutover date as specified in the original ED, to estimate what your exposure is.
Tuesday, July 26, 2011
Second Exposure Draft coming
I need to catch up on the boards' activity over the last two months. I've taken a summer hiatus, but they didn't...
The most important news is that at the July 21 meeting, the boards unanimously decided to release a second Exposure Draft. The changes to the proposed standard from the original Exposure Draft are so significant that they felt it important to get feedback from interested parties. Some decisions remain to be made before the new Draft can be released; they expect to complete those deliberations during Q3, with a new Draft released soon after. The wording seems to suggest that the Draft would come out in early October.
Additional decisions reached this month:
Lessor Accounting
The performance obligation model has been scrapped. All leases (except for short-term leases) will be accounted for using a "receivable and residual" model, which is essentially the same as the "derecognition approach" described in the Exposure Draft. Main points of this model:
* The lessor recognizes a right to receive lease payments (matching the lessee's obligation to make payments) and a residual asset.
* The discount rate to present value the payments is the "rate the lessor charges the lessee" (the internal rate of return, based on the asset's value).
* The residual asset accretes (increases using the interest method, same interest rate) over the lease's life.
* If the asset's carrying amount is lower than the lease's value, a profit (on the portion of the asset represented by the lease receivable) can be recognized at commencement of the lease if reasonably assured.
Short-term leases, defined as those with a maximum term of 12 months or less, will be accounted for as operating leases (no balance sheet effect, just income recognized over the lease term on a systematic basis, usually level). This will protect against needing to do convoluted accounting for things like rental cars and hotel rooms.
Operating lease accounting will also be permitted for leases of investment property measured at fair value. This is currently only available under IFRS (IAS 40). But the FASB is working on a proposed investment property standard which would be similar, with an Exposure Draft scheduled for Q3 2011.
Contingent Rents Dependent on an Index or Rate
While other contingent rents are excluded from the capitalized calculation of leases, those that depend on an index or rate have to be included. An example would be a lease whose rent is based on CPI or LIBOR. Such leases are to be initially measured based on the index/rate at the commencement of the lease, then recalculated at the end of each reporting period using the new index/rate. The change is booked to net income if it applies to the current reporting period, or as an adjustment to the right-to-use asset (for a lessee) for adjustments that relate to future periods. Lessors would recognize an adjustment in the receivable in profit or loss.
This is a potentially significant cause of recalculations on leases; many real estate leases have CPI escalators that adjust every year. The boards decided that the benefit of more accurate presentation of actual rents due outweighs the effort required.
Lessee disclosures
The boards approved a lengthy set of disclosures for lessees:
* Reconciliation of opening & closing balance of right-to-use assets, disaggregated by class of underlying asset
* Reconciliation of opening & closing balance of lease liabilities (no disaggregation required)
* Future rent commitments, similarly to current FAS 13 requirements (by year for five years, then all remaining, then subtracting interest to reconcile to the liability balance). Note that this is different from current IFRS requirements. Preparers would have the option to disclose by year for more than 5 years, if that would provide better information.
* Information about leases signed but not yet started if they create "significant" rights and obligations
* Information about contingent rentals and options
* A table of expenses: amortization, interest, variable payments, and short-term rents, plus a breakdown of principal and interest paid
* Information regarding any expected material changes in short-term rentals
However, they explicitly are not requiring disclosure of discount rates, fair value of liabilities, purchase options, or initial direct costs.
They also explicitly forbid combining interest and amortization expenses and presenting the total as lease or rent expense.
The boards split over whether or not to disclose future commitments for services and other non-lease components; the FASB wants such disclosure (which is already required by the SEC in the unaudited portion of the financial statements), while IASB does not. Presumably this will be reconciled at a later date (perhaps after the Exposure Draft is released and reviewed).
Lessee primary financial statements presentation
Lease right-of-use asssets and liabilities either must be presented separately in the Statement of Financial Position (balance sheet), or shown separately in footnote disclosures. The right-of-use asset is to be presented according to the type of underlying asset (land leases with land owned assets, etc.). They have decided not to define whether the right-of-use asset is tangible or intangible. This is a question that affects some regulated industries for tax and other purposes. The boards have decided to let the relevant regulatory bodies make the determination appropriate to their purposes.
The Statement of Cash Flows would show principal and interest payments in accordance with requirements for other financing. Variable lease payments (not capitalized) and short-term rentals are operating cash flows. New leases (creating a new asset & liability) would be an additional non-cash disclosure.
June meeting results in next post...
The most important news is that at the July 21 meeting, the boards unanimously decided to release a second Exposure Draft. The changes to the proposed standard from the original Exposure Draft are so significant that they felt it important to get feedback from interested parties. Some decisions remain to be made before the new Draft can be released; they expect to complete those deliberations during Q3, with a new Draft released soon after. The wording seems to suggest that the Draft would come out in early October.
Additional decisions reached this month:
Lessor Accounting
The performance obligation model has been scrapped. All leases (except for short-term leases) will be accounted for using a "receivable and residual" model, which is essentially the same as the "derecognition approach" described in the Exposure Draft. Main points of this model:
* The lessor recognizes a right to receive lease payments (matching the lessee's obligation to make payments) and a residual asset.
* The discount rate to present value the payments is the "rate the lessor charges the lessee" (the internal rate of return, based on the asset's value).
* The residual asset accretes (increases using the interest method, same interest rate) over the lease's life.
* If the asset's carrying amount is lower than the lease's value, a profit (on the portion of the asset represented by the lease receivable) can be recognized at commencement of the lease if reasonably assured.
Short-term leases, defined as those with a maximum term of 12 months or less, will be accounted for as operating leases (no balance sheet effect, just income recognized over the lease term on a systematic basis, usually level). This will protect against needing to do convoluted accounting for things like rental cars and hotel rooms.
Operating lease accounting will also be permitted for leases of investment property measured at fair value. This is currently only available under IFRS (IAS 40). But the FASB is working on a proposed investment property standard which would be similar, with an Exposure Draft scheduled for Q3 2011.
Contingent Rents Dependent on an Index or Rate
While other contingent rents are excluded from the capitalized calculation of leases, those that depend on an index or rate have to be included. An example would be a lease whose rent is based on CPI or LIBOR. Such leases are to be initially measured based on the index/rate at the commencement of the lease, then recalculated at the end of each reporting period using the new index/rate. The change is booked to net income if it applies to the current reporting period, or as an adjustment to the right-to-use asset (for a lessee) for adjustments that relate to future periods. Lessors would recognize an adjustment in the receivable in profit or loss.
This is a potentially significant cause of recalculations on leases; many real estate leases have CPI escalators that adjust every year. The boards decided that the benefit of more accurate presentation of actual rents due outweighs the effort required.
Lessee disclosures
The boards approved a lengthy set of disclosures for lessees:
* Reconciliation of opening & closing balance of right-to-use assets, disaggregated by class of underlying asset
* Reconciliation of opening & closing balance of lease liabilities (no disaggregation required)
* Future rent commitments, similarly to current FAS 13 requirements (by year for five years, then all remaining, then subtracting interest to reconcile to the liability balance). Note that this is different from current IFRS requirements. Preparers would have the option to disclose by year for more than 5 years, if that would provide better information.
* Information about leases signed but not yet started if they create "significant" rights and obligations
* Information about contingent rentals and options
* A table of expenses: amortization, interest, variable payments, and short-term rents, plus a breakdown of principal and interest paid
* Information regarding any expected material changes in short-term rentals
However, they explicitly are not requiring disclosure of discount rates, fair value of liabilities, purchase options, or initial direct costs.
They also explicitly forbid combining interest and amortization expenses and presenting the total as lease or rent expense.
The boards split over whether or not to disclose future commitments for services and other non-lease components; the FASB wants such disclosure (which is already required by the SEC in the unaudited portion of the financial statements), while IASB does not. Presumably this will be reconciled at a later date (perhaps after the Exposure Draft is released and reviewed).
Lessee primary financial statements presentation
Lease right-of-use asssets and liabilities either must be presented separately in the Statement of Financial Position (balance sheet), or shown separately in footnote disclosures. The right-of-use asset is to be presented according to the type of underlying asset (land leases with land owned assets, etc.). They have decided not to define whether the right-of-use asset is tangible or intangible. This is a question that affects some regulated industries for tax and other purposes. The boards have decided to let the relevant regulatory bodies make the determination appropriate to their purposes.
The Statement of Cash Flows would show principal and interest payments in accordance with requirements for other financing. Variable lease payments (not capitalized) and short-term rentals are operating cash flows. New leases (creating a new asset & liability) would be an additional non-cash disclosure.
June meeting results in next post...
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