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So far this year, there
have been a number of meetings held by both
the FASB and the IASB (jointly and separately)
that have discussed lease accounting. We
summarize the meetings below, based on
information posted online, with links to the
online resources provided and the most
significant information and conclusions noted
in bold.
Working group meeting
February 15, 2007, in London.
A number of papers prepared
for the working group to review, and audio
recordings of the entire meeting, have been
posted
on the IASB web site.
From the prepared papers:
• As previously mentioned,
the “New Approach” suggested by the staffs of
the FASB, IASB, and other accounting boards
(the “G4+1”) would call for capitalizing all
currently operating leases using the present
value of the minimum rents. An important
theoretical underpinning for this is found in
the fact that accounting research has shown
that levels of both capital leases and
present valued operating rent commitments are
correlated with stock price volatility
(“equity risk”) in the same way that debt
levels are (though not precisely in size).
This goes to the heart of the “if it walks
like a duck” argument; the impact is similar
to debt, so it should be treated similarly to
debt. Interestingly, contingent rents such as
percentage of sales clauses had no such
correlation to equity risk.
• Research documents a
clear pattern of eliminating capital leasing
and replacing it with operating leases since
the adoption of FAS 13. At the same time,
research found no significant impact on equity
risk from the adoption of FAS 13, even on
companies with large capital lease portfolios.
• The FASB/IASB staff
report offers four conceptual “models” for
viewing leases: right to use, whole asset,
executory contract, and current standards.
• Right to use means
recognizing an asset and liability (by the
lessee) for the period covered by the lease.
This is their preferred approach.
• Whole asset means
the entire fair value of the item is
capitalized on the lessee’s books, with two
liabilities, one for the period covered by the
lease, and one representing the responsibility
to return the item to the lessor. The staff
believes this overstates a lessee’s assets and
liabilities, because the value after the end
of the lease should not be considered an asset
of the lessee; it is simply held in trust for
the lessor.
• Executory contract
is essentially the current method of
accounting for operating leases. The staff
believes this is based on a misconception that
the rights in a lease are conditional (use is
based on continued lease payments), which is
not a valid characterization of a
non-cancellable lease.
• The current method
is essentially a hybrid of the whole asset
model (for capital leases) and executory
contract model (for operating leases). Since
both of those models have identified flaws,
and the staff “do not think that the rights
and obligations arising under an operating
lease are conceptually any different from
those arising under a finance [i.e., capital]
lease,” they therefore do not favor
maintaining this model.
• A survey done last year
in the United Kingdom of both corporate
finance directors (“preparers”) and financial
analysts (“users”) found that both agreed that
“the current lease standards were incomplete,
inconsistent, open to manipulation, lacked
uniformity and clarity, and did not portray
the substance of the transactions. Both
users and preparers were equally supportive of
a single-lease-model approach for any new
standard.”
From the audio recordings
of the meeting:
• There is clearly strong
interest from the boards and staffs of FASB
and IASB in this topic. Several board members
of each of FASB and IASB participated in the
meeting. The moderator of the meeting passed
on a comment that the chairman of the IASB,
Sir David Tweedie, has made a number of times
in connection with the overall need for
accounting reform, saying that it is his
ambition, before he dies, to fly in an
airplane that is shown on the balance sheet of
the airline flying him. (Currently, almost all
commercial airplanes are held as operating
leases.) Chairman Tweedie considers the
current lease accounting standard
“fundamentally broken.”
• The boards & staffs are
concerned that FAS 13/IAS 17 are inconsistent
with the conceptual frameworks of accounting
that have been laid out in the years since
these standards were promulgated. They believe
that this inconsistency has resulted in lease
accounting being inconsistent with current
standards on financial instruments and
business combinations, as well as current
projects in insurance accounting and revenue
recognition, among others.
• The SEC estimates the
total U.S. future rent commitments on
operating leases (undiscounted) at
approximately $1.25 trillion. An
analyst reported his estimate that 70% of this
is real estate.
• The working group
includes members of the boards and staffs as
well as lessees, lessors, auditors, and
analysts. Several people noted that many
users of financial reports are already
attempting to present value future lease
commitments for analysis purposes, but the
information they have is incomplete. (FCS has
at least one client that has chosen to provide
the present value of operating leases as a
footnote to its financial statements, but this
is extremely rare.) On the other hand, one
analyst suggested that for short-life assets
like computers, copiers, and cars, it is most
appropriate to view the leases as an ongoing
operating expense, rather than a balance sheet
matter.
• There is a serious
concern that companies will attempt to
circumvent whatever rules are promulgated to
keep leases off their balance sheets. The
boards are very aware of what has been done
under the current regime in this regard.
• Both boards considered a
simple, non-cancelable lease, and concluded
that a lessee has a right to use that meets
the definition of an asset, and an
obligation to make payments that meets the
definition of a liability. The requirement to
return the asset at the end of the lease does
not meet the definition of a liability, nor
does the lessor's obligation to allow use of
the asset.
• The boards tentatively
concluded that the right of use approach is
the only approach that results in the
recognition of the assets and liabilities
identified in a simple lease.
• The boards noted
that issues of measurement and recognition
remain to be explored, and could affect these
preliminary determinations.
The issue at this meeting
was the scope of transactions covered by lease
accounting regulations. The boards concluded
that at the present time, the scope will
not change from current lease accounting
regulations, but as the model develops, the
boards will consider applicability to other
transactions, specifically intangible assets,
which may be included before the Preliminary
Views document is released. It was also noted
that both lessee and lessor accounting are
included in this project.
IASB meeting on
May 15
This was a discussion-only meeting, regarding
handling options to renew or terminate early.
No decisions were reached.
Both boards considered
measurement of the asset and liability of a
lessee lease. The boards tentatively agreed
to measure the initial liability at "fair
value," as that term is defined in FAS
157and IAS 39, with subsequent measurement
based on the effective interest method with
an option to fair value. For the asset, the
IASB prefers measurement based on the nature
of the leased item (equipment would be
measured similarly to purchased equipment),
while the FASB considers that inappropriate
and directed the staff to research further a
lease-specific measurement model. It is not
clear how the boards will reconcile their
differing views to reach a joint standard.
No discussion has yet been
reported regarding the transition to the new
system. We do not know whether existing leases
will be restated from inception, set up for
their remaining life at the cutover date, or
grandfathered. This will undoubtedly be a very
contentious issue. A Georgia Tech accounting
professor recently
studied the potential impact of making all
current operating leases capital, and concluded
that some retail companies (his focus) could
face huge impacts to their reported earnings and
financial leverage ratios, but the amount of
impact would certainly depend on exactly how the
transition is effected.
We will continue to carefully monitor developments. Our
offices are located just a few miles from the
FASB headquarters, and we expect to be present
at any meetings held there that deal with leases.
We will update our software as soon as the new
standard is released, and will provide you with
the ability to compare old and new results.
Both EZ13
and our lease accounting service
offer reports based on the New Approach concept
of capitalizing all leases at their present
value; please contact us for details if you
would like to run such reports. To the extent
that any changes in regulations require altering
lease information in a systematic way, we will
endeavor to provide automated update facilities.
However, depending on the regulations adopted,
it may be necessary to go through your lease
database record by record to review and make
changes. We cannot know
the exact situation until the new standards
are published. We will provide updates on our
website as new information is released.
Return to FCS home page
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with your lease accounting needs, now and in
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