Results of joint FASB/IASB meeting, Nov. 18

The FASB and IASB had a joint meeting via videoconference today. Among several topics of discussion was lease accounting, for both lessees and lessors. The staff’s agenda papers are available at the IASB’s web site (where you can also view an archive of the webcast). Discussion was lengthy enough that the 2-1/2 hours allocated were insufficient, and so discussion of contingent rents was postponed until a December 16-17 joint meeting.

In general, the boards agreed with the staff’s presented recommendations, some of which varied from their preliminary views as presented in the discussion paper (see previous entries in this blog); the changes were prompted by comments on the discussion paper. Some highlights of changes from the preliminary views:

• Interest rate for present valuing the rents: The preliminary views called for the lessee always to use their incremental borrowing rate. After lengthy discussion, the boards agreed to permit use of the implicit rate if it is readily determinable.
• Initial direct costs associated with a lease will be capitalized by the lessee and amortized over the lease term; a lessor will likewise add initial direct costs to the lease receivable and amortize them (using the interest method). Some members of the boards wanted to clarify that this applies only to incremental costs incurred, not to an allocation of salaries and other expenses that the company would be paying whether or not a lease was signed.
• The boards agreed that the incremental borrowing rate should not be changed during the life of the lease (as long as the lease term is not changed). This had been previously a point of disagreement between the boards.
• Impairment of leased assets will be determined based on existing impairment standards (which are different for US GAAP and IFRS). Similarly, revaluation will be based on the separate standards (US GAAP does not permit revaluation, while IFRS permits it under limited conditions).
• The initial measurement of a lessor’s lease receivable will be based on the present value of the rents, using the lease’s implicit rate (it was noted that this could be different from the explicit rate when promotional rates, like 0% interest, are being offered).
• Subsequent measurement of the receivable will be at amortized cost using the effective interest rate (like a current capital lease).
• The lessor’s performance obligation (a credit) will be equal to the receivable at lease inception (including any initial direct costs that are added to the receivable as noted above).
• The performance obligation would normally be amortized on a straight-line basis unless another method is more representative of usage (there was some discussion of whether the usage pattern would only be time-based as opposed to unit-based; I’m not sure if a conclusion on that was reached).
• For recognizing options in the lease term, the boards adopted an altered determination of the term suggested by some discussion paper respondents: rather than the “most likely lease term,” the standard is now “the longest possible lease term that is more likely than not to occur.” Thus, if there were a 40% possibility of the first option being exercised, and a 20% possibility each of exercising through options 2, 3, and 4, options 1 & 2 would be included, because the likelihood that the life will be longer is less than 50%. This applies to both lessees and lessors.
• In determining when options are to be included, the discussion paper stated that the review should include contractual, non-contractual, and business factors, but not past practice and lessee intention. That has been changed, and the boards now state that all factors, including past practice and lessee intention, should be considered. The boards are concerned that companies may use “intention” to game the results, but noted that intention will not trump other factors, but will be one of several factors to consider.
• Reassessment of whether options should be included, while in theory required each reporting date, need only be undertaken when facts and circumstances have changed, not simply due to the passage of time.

FASB/IASB joint meeting

Earlier this week, the FASB and IASB held a joint meeting in London. Among the many topics discussed was leases. According to the Summary of Board Decisions, the following important decisions were made:

* The boards reaffirmed the right-of-use approach for lessees. (IOW, the pleas of many discussion paper comments to keep operating lease accounting have been rejected.)
* The boards have decided to accept the idea of "in substance purchases" as being different from leases; they will be excluded from the scope of lease accounting. Criteria will be developed to identify which contracts should be so treated.
* The boards agreed to use a performance obligation approach for lessor accounting--the asset is not removed from the books, but a liability is set up to reflect the obligation to permit use of the asset, balancing the receivable for the rental stream.
* Lessors will no longer be permitted to recognize a profit at the beginning of the lease; everything will be recognized over the lease term.
* A lease will now need to be reflected on the balance sheet (presumably for both lessees and lessors) as soon as the contract is signed, rather than the current practice of waiting until the asset is delivered. However, until delivery it is to be recognized "net" only, which means that in most cases there will be nothing to report (assets and liabilities are equal), except in case of an impairment. Disclosures (in footnotes, not the primary financials) would be required to detail the assets and liabilities, at least when there is a significant gap in time between signing and delivery and/or the amounts are significant.

The boards will discuss further issues in November, including
* initial and subsequent measurement of the asset and obligation
* treatment of leases with options
* contingent rentals and guaranteed residuals

FASB review of comment letters

This morning, the FASB met to review the comment letters to the Preliminary Views document. No decisions were made at the meeting. The audio is available until the next meeting at http://fasb.trz.cc/archive.php.

A few notable items from the discussion:

• There is concern that more attention needs to be given to distinguishing between a service contract and a lease. Up to now, the accounting for operating leases and service contracts hasn't been significantly different, so it hasn't been a big issue. But with leases subject to capitalization, the difference becomes much more substantial, so people are much more concerned. The board plans to discuss this issue in more depth in upcoming months.
• As previously noted, many respondents disagree with including options in the capitalized value of a lease. Some members of the FASB are concerned that options are being handled inconsistently in different aspects of accounting (such as financial instruments and revenue recognition)--some are handled through recognition, others through measurement.
• There has been a background discussion of "in-substance purchases" throughout the entire lease accounting project. This reappeared, with the mention that the Leases Working Group meeting earlier this month brought up the issue as being very important to lessors, probably more important than to lessees. The definition of "in-substance purchase" seems to be confined to leases with an ownership transfer or bargain purchase option (the first two tests of capitalization under FAS 13, which currently require the leased asset to be depreciated over the economic life rather than the lease term). Lessors particularly want such leases to be treated like purchases, rather than with right-to-use accounting.
• Some respondents questioned whether appropriate due process would be followed if lessor accounting didn't go through a preliminary views document. Board members do not think that is a due process requirement; they believe it is sufficient to provide an exposure draft and respond to comments to that. The implication is that they don't want to slow down completion of the leasing project.

The FASB and IASB will have a joint meeting October 26-28. Lessor accounting is part of the agenda for that meeting.

Correction: In my August 27 blog entry, I said that the September 3 meeting of the Leases Working Group was the first in 2-1/2 years. That was incorrect. The Group also met on October 7, 2008, to discuss the proposed Preliminary Views document. A summary of the meeting is available here, but I won't take the time to review it in this blog, since it's pretty old news by now. I have not yet seen any information (or audio) posted about the September 3 meeting.

Comment letters summary

The FASB and IASB staffs have prepared a summary of 290 comment letters received on Leases: Preliminary Views, the discussion paper released in March, for which the comment period ended in July (though letters were received through mid-August; they cut off review with the letter received on August 10, while 5 more were received in the following week). The summary is available on the IASB web site. The boards plan to discuss the summary next week: The IASB's meeting will be Sep. 15, while the FASB will meet on Sep. 16. Both meetings will be broadcast on the web (IASB includes video, while the FASB is audio only; follow the links to sign up).

Some highlights from the staff's summary (you can see my less systematic review in a prior post):

* Almost half of the respondents were "preparers" (companies and other entities that need to prepare financial statements), with another 51 from industry organizations. The rest were a range of professional associations, accounting firms & standard setters, government agencies, academics, financial statement users, and individuals not claiming other affiliations. Almost half were from Europe, with a third from North America, an eighth from international organizations, and a small number from the rest of the world.

* About half supported the overall concept of a right-of-use asset and corresponding obligation for all leases; a third were opposed, and the rest did not express opinion (in most cases because they were focused on lessor rather than lessee accounting). However, most of those in support also expressed reservations about complexity, especially in dealing with options and contingent rents. Those opposed (virtually all of whom were preparers or industry organizations) largely encouraged keeping the current model with enhanced disclosure.

* "Nearly all of the respondents who commented on the boards' decision to defer consideration of lessor accounting disagree with that decision." People are concerned that the transactions will be unbalanced, and that eventual lessor accounting decisions may require further changes to lessee accounting at considerable extra cost and complexity.

* Most respondents agree with the current scope for lease accounting, though some are concerned that the new rules will lead to pressure to recharacterize leases as service contracts (which are not capitalized). Most who commented favor excluding short-term leases (generally favoring one year as the cut-off) but including "non-core" leases.

* Nearly all respondents agree with valuing the asset and obligation at the present value of the rents, though they were divided on whether lessees should attempt to determine and use the lease's implicit interest rate instead of the incremental borrowing rate.

* Respondents were divided on whether or not options (renewal and purchase), contingent rents, and residual guarantees should be included, with many of those opposed asserting that they do not fit the accounting framework definition of a liability, and also expressing concern about the complexity that would be entailed.

* If contingent rents are included, about half believe the estimates should be updated each reporting date (the boards' tentative view), to provide more accuracy. Others consider this requirement onerous, and would limit it to when a triggering event (to be defined) occurs. If changes in contingent rents happen, most prefer to see it recognized through a change in the carrying amount of the right-to-use asset, not a P&L gain/loss.

* Most who expressed an opinion on lessor accounting wish to see the transaction set up as a derecognition of (a portion of) the existing asset, rather than the performance obligation approach that the boards favored in their July meetings.

* Most who expressed an opinion believe that investment properties should be included in the scope of a lessor accounting standard. However, almost all investment property companies themselves argued against inclusion.

We'll see how significant the comments are in the boards' deliberations next week and over coming months.

Upcoming Leases Working Group meeting

When the FASB & IASB decided to revise the lease accounting standard back in 2006, they called for members of academia, public accounting, and the world of publicly held companies to volunteer to serve on an advisory panel, called the Leases Working Group. A first meeting was held in January 2007 to discuss the various issues surrounding lease accounting, and get the group's input on possible approaches to deal with the problems.

Then the boards seemed to forget the group existed. It has been over 2-1/2 years since the group met. Finally, on September 3, a second meeting of the Leases Working Group will be held in London. It's planned as an all-day event. Unlike IASB board meetings, this meeting will apparently not be available for live online listening; however, they have promised that audio will be available at a later time. Anyone who wants to attend the meetings live may do so, but needs to register in advance on the IASB website.

Agenda papers for the meeting are also available at the IASB website. They indicate that the issues to be discussed are largely issues that were not covered by the Preliminary Views discussion paper, though there will be a brief review of the 295 comment letters received. Instead, the topics to be discussed are mostly matters that the boards have discussed in their May, June, and July meetings: impairment, revaluation, initial direct costs, sale & leaseback transactions, transition, and lessor accounting, plus in-substance purchases, which some members feel should be accounted for differently than other leases. That has been mentioned at prior meetings, but there has been no in-depth discussion on the topic. Many of the topics for review are ones where the two boards have taken different positions; a number of comment letters urged the boards to come to an agreement on these topics (many respondents felt a unified standard was more important than which position was taken). More detailed information on the topics is available at the IASB's web site, among the agenda papers for prior board meetings (the appropriate papers are noted on p. 3 of the working group's agenda paper #1).

The working group will have to move at a fast pace; less than half an hour per issue has been allotted for the lessee topics, plus 90 minutes for lessor accounting and 45 minutes for in-substance purchases.

The boards plan to discuss the comment letters at meetings in September, and lessor accounting at October meetings. At this point, the schedule for the leases project still indicates an exposure draft in the second half of 2010, and a final standard in the first half of 2011. Whether the boards will stick with that after the September and October meetings, in the face of substantial public pressure for a simultaneous release of new lessee and lessor standards and a large amount of work to do on both sides of the transaction, remains to be seen.

Comment letters update, lessor accounting

The IASB continues to post comment letters to its web site. As I write this, the count stands at 272, with a notation that "Comment Letters are currently being uploaded to the website." However, fewer than 10 letters have been posted this week. It looks like these are letters received after the deadline, which they are choosing to still include (some of the cover letters have dates after July 17).

At a joint FASB/IASB meeting on July 23, the boards announced that they would review the comment letters at a meeting in September.

At the same meeting, the boards reached the following tentative decisions on lessor accounting (reported in the FASB Action Alert):

1. Initial measurement of the lessor’s right to receive rental payments would follow existing literature for the accounting for financial assets under either IFRSs or U.S. GAAP (IAS 39, Financial Instruments: Recognition and Measurement, for IFRSs and Section 310-10-30 of the FASB Accounting Standards Codification™ for U.S. GAAP).
2. Initial measurement of the lessor’s right to receive rental payments under U.S. GAAP would be discounted using the interest rate implicit in the lease.
3. Initial measurement of the lessor’s performance obligation would equal the customer consideration received (that is, on initial measurement the performance obligation would equal the lessor’s receivable).
4. Subsequent measurement of the lessor’s performance obligation would reflect decreases in the entity’s obligation to permit the lessee to use the leased item over the lease term.

However, they note that all of these decisions presuppose maintaining the overall concept of setting up a performance obligation for lessors (the original asset remains on the books, and a receivable is added to assets with a matching performance obligation as a liability). A number of comment letters have criticized that decision, in part because it seems not to mirror lessee accounting, and the boards have instructed their staffs to do additional analysis of a different model that would derecognize the asset to the extent of the lease. (This was the staff's preference presented to the boards at their May meetings, as previously mentioned on this blog.)

DP comment letters

The comment period has now closed for the discussion paper, Leases: Preliminary Views, released by the FASB & IASB in March. A flood of comment letters came in close to last Friday's deadline; as of this posting, the comment letters page lists over 200 comment letters received, with a notation that additional letters have yet to be posted.


Letters have been received from almost every conceivable type of party: accounting firms, accounting boards, lessees, lessors, associations of lessees and lessors, accounting academics, and even a few individuals. (FCS's comment letter is available here.) Interestingly, even though a major reason for the proposed revision is to provide better information to users of financial statements (i.e., investors and lenders), I see only a couple of comment letters from such entities, so we have little basis to know whether they feel the changes would help them make better investing decisions. We only have the claims of other interested parties that this or that change would or wouldn't be useful to statement users.


While I haven't had time to read all the comment letters, most of them fall in predictable ways. Accountants generally favor the overall approach, though they may have issues with some of the details. Most lessors and many lessees don't like the elimination of operating leases; many are also concerned about the increased complexity, particularly if reassessment every reporting period is required. (Some comment that lessees made their decisions to lease based on the current rules, and requiring capitalization of existing operating leases messes up their capital structures.) Some lessees are more sanguine about the general approach; JCPenney, for instance, says that it has long been internally managing its capital structure as if real estate operating leases were capitalized, so making that change on the external books is no big deal, and makes a lot of sense to them (though they'd still like to exclude small leases).

Several letters (such as the Office of Advocacy of the U.S. Small Business Administration) express concern about the impact on small businesses leasing items like computers and copiers; the impact on their financial statements, the complexity involved in calculating and amortizing present valued obligations, and the hassles of reconciling differing treatment between book and tax accounting were mentioned as issues. A number of letters suggest that small or short-term leases should be excluded to reduce the reporting burden, considering that the impact would generally be immaterial; other letters (particularly from accounting firms) oppose any exclusions, concerned that it opens the door to evasive manuvers.

Overall, it seems like virtually every question has respondents on both sides of the issue, often with very carefully thought-out reasons. Still, it's not hard to see the "whose ox is being gored" aspect of many of the comments: lessors are concerned that if all leases are capital, many companies will buy instead of lease as the off-balance-sheet benefit disappears (even as they claim that that's rarely why lessees take leases); lessees with lots of operating leases are concerned about the effect on their balance sheet of capitalizing those leases; some academics and accountants seem to be pursuing theoretical accuracy with no concern for the practical costs (while others are very aware of their clients' pain).


There are, however, some areas of general agreement. Virtually no one likes the idea of recalculating the obligation to reflect changes in a lessee's incremental borrowing rate, considering that it adds complexity and doesn't reflect a change in the actual economics of the lease. Very few like the idea of revaluing the obligation at fair value, for similar reasons. Recognizing options and contingent rent based on the most likely amount rather than probability weighting is strongly favored (though many don't want to recognize options until actually exercised or reasonably assured, or contingent rent until incurred, both of which are the current rules). Respondents generally agree with treating residual guarantees similarly to contingent rents.


There is a great deal of concern with complexity and cost, particularly the requirement to reassess at each reporting period (especially with regard to contingent rents). Many respondents suggest that contingent rents should only be capitalized if the regular rents are clearly below-market (otherwise, they would be expensed as incurred, as under current rules). Some accountants, though, believe reassessment is desirable to more accurately portray the current state of the leases. Another area of complexity mentioned by a number of American respondents is book/tax differences which would be generated by treating current operating leases as capital (when they would still be operating or "true leases" for tax purposes).

A large number of letters call for lessor lease accounting to be included in the revision, wanting to make sure that lessee and lessor accounting continue to mirror each other, rather than operate under different standards. Some are concerned, though, that the boards may rush their lessor accounting review to stay on the current lessee schedule.

CFO magazine has an article about the comment letters on their website.