This morning the FASB met with the Small Business Advisory Committee. The meeting is continuing as I write this, but discussion on leases was near the beginning of the agenda, and that's what I'm concerned with.
A FASB staff member gave a bit of an update of the outreach they've been doing since the February meeting, when the FASB and IASB considered some options for expense recognition on leases in the new standard. They've been meeting both with companies that would apply the standard ("preparers") and analysts ("users"). They've found that among users, there is near unanimity in agreement on the balance sheet approach planned for the new standard (i.e., capitalizing essentially all leases). There is, however, considerable diversity on the income statement side, selecting from among the options that the board is considering.
The presentation at this meeting included three alternatives to the current capital/finance lease model, rather than the two discussed at the February meeting. In addition to February's interest-based amortization and underlying asset approaches (see my prior summary of these), they showed an "Approach D," which is straight-line rent expense, like current operating lease accounting. It wasn't clear how the balance sheet balances would be amortized in such a situation: Would the asset and liability be shown undiscounted, and then amortized straight-line, or would they be shown as the present value of remaining rents (either based on cash rents or the straight-line equivalent), or something else?
In general, the committee expressed strong support for level expense recognition, considering that capital lease accounting provides unhelpful information in their environment. Some still want to make the case for it being off the balance sheet ("If I can't sublet, do I really have an asset, since I can't transfer it?") I don't see any likelihood of that prevailing.
Some expressed support for handling real estate differently from equipment, making the argument that real estate leasing is more about reducing risk (knowing what your rent will be into the future) while equipment has more of a financing approach (I can't afford to buy it up front; though often an equipment lease is related to wanting the equipment for a limited time, wanting quicker upgrades, etc.). This was in support of level expense recognition for real estate even if equipment used the standard financing model.
A FASB board member, however, said he didn't like the idea of basing the accounting on the type of underlying asset. He wondered if they could define characteristics that justified the different treatment. One that he mentioned is that in a real estate lease, the asset is expected to have little or no reduction in value (a land lease particularly exemplifying this concept).
Another committee member suggested that if the present value of the rents is less than "about" half the value of the underlying asset, operating lease accounting should be acceptable. But he didn't have a good answer for how to draw the line between leases that would and wouldn't qualify. A major issue driving the revision of lease accounting is that similar leases (those just barely on opposite sides of the capital vs. operating dividing line) are accounted for very differently.
A banker commented that many leases are written to game the accounting rules, and she fully expects the same thing to happen under the new rules. A particular area of potential vulnerability that several people saw is the issue of substitutability--according to the current draft, a lease requires a specific asset to be named, and if the asset can be freely substituted (so that it's the output of the asset, rather than the asset itself, that the lessee is controlling), it's a service contract rather than a lease. It was suggested that lessors may start writing leases so that all kinds of equipment are officially subject to substitution. Whether "substance over form" principles will protect against that is unclear.
Thursday, May 10, 2012
Friday, April 13, 2012
No lease accounting discussion this month
At the February meeting, the FASB & IASB directed the staffs to conduct outreach on the alternative expense recognition possibilities considered. The plan at the time was for results of the outreach to be discussed at the boards' combined meeting in April. The agenda for April has now been released, and leases are not on the list. So yet another month of delay for finalizing the revised exposure draft...
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.
Wednesday, March 14, 2012
Yet another delay
As previously mentioned, the last substantive issue the boards are discussing is the expense profile of lessee leases. Capital lease accounting under FAS 13/IAS 17 results in more expense in the early months/years of the lease than at the end, because interest expense is accrued on the remaining obligation, which declines over the life of the lease, while depreciation expense is usually equal through the lease's life. Operating leases, on the other hand, show level rent expense throughout their life (even if the rent increases).
There has been a great deal of pushback from lessees about applying this expense profile to all leases. They argue that front-loading the expense doesn't reflect actual usage and costs; it also means a mismatch with likely benefits, since income tends to rise over time. If managers are reviewed based on profitability, front-loaded expenses may skew the view of how well or poorly they're actually doing.
At the FASB/IASB meeting Feb. 27-29, the boards considered two alternatives to current capital lease accounting, each of which would reduce or eliminate the front-loading of expenses. The alternatives are:
The boards split in their positions. Some board members want to maintain capital lease accounting for all leases, but a majority of the FASB favors interest-based amortization, while a majority of the IASB favors the underlying asset approach. However, the overall conclusion was that more "outreach" is needed, discussing the options with both statement preparers and users; the underlying asset approach in particular is a very new concept which has received little review. Therefore, the boards are going to take two months to meet with interested parties, and plan to continue discussions in April with the results of their outreach.
Given that once this is settled, the boards need to decide if there is any impact on lessor accounting, and then they need to talk about final details such as the comment period and interim disclosures, it looks like we're not going to get a revised exposure draft before June.
IASB/EFRAG meeting
The IASB met March 9 with EFRAG, the European Financial Reporting Advisory Group, to discuss several current IASB projects. EFRAG wants to keep the current distinction between capital and operating leases, with just minor improvements to determining when leases ought to be considered financing transactions and therefore capitalized. That seems unlikely.
There has been a great deal of pushback from lessees about applying this expense profile to all leases. They argue that front-loading the expense doesn't reflect actual usage and costs; it also means a mismatch with likely benefits, since income tends to rise over time. If managers are reviewed based on profitability, front-loaded expenses may skew the view of how well or poorly they're actually doing.
At the FASB/IASB meeting Feb. 27-29, the boards considered two alternatives to current capital lease accounting, each of which would reduce or eliminate the front-loading of expenses. The alternatives are:
- Interest-based amortization: Depreciation would be based on the "present value of remaining economic benefits." As a practical matter, unless there's a reason to think the benefits provided by the asset will dramatically change in value during the lease, the depreciation recognized will be equal to the reduction in the obligation balance if the rent is equal over the life of the lease. If rents are unequal, the depreciation will be equal to what the reduction in obligation would be if the rents were leveled.
The expectation is that if this method is chosen, it would not apply to all leases. More or less all leases that currently are considered capital would be accounted for the same way as they are now, to keep their accounting more consistent with purchase accounting. - Underlying asset approach: Depreciation would be based on a combination of the portion of the underlying asset expected to be consumed during the lease term plus unwinding the discount on the expected residual value. The effect is that for a real estate lease, where the expected future value is the same as or more than the current value, depreciation would be the same as for interest-based amortization, and the expense profile would be flat. For an asset expected to be fully consumed by the end of the lease term (zero residual), the expense profile would be the same as current capital lease accounting. A residual value in between would give a proportionally interim result.
The boards split in their positions. Some board members want to maintain capital lease accounting for all leases, but a majority of the FASB favors interest-based amortization, while a majority of the IASB favors the underlying asset approach. However, the overall conclusion was that more "outreach" is needed, discussing the options with both statement preparers and users; the underlying asset approach in particular is a very new concept which has received little review. Therefore, the boards are going to take two months to meet with interested parties, and plan to continue discussions in April with the results of their outreach.
Given that once this is settled, the boards need to decide if there is any impact on lessor accounting, and then they need to talk about final details such as the comment period and interim disclosures, it looks like we're not going to get a revised exposure draft before June.
IASB/EFRAG meeting
The IASB met March 9 with EFRAG, the European Financial Reporting Advisory Group, to discuss several current IASB projects. EFRAG wants to keep the current distinction between capital and operating leases, with just minor improvements to determining when leases ought to be considered financing transactions and therefore capitalized. That seems unlikely.
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, January 31, 2012
EZ13 and Asset Retirement Obligations (ARO)
We are delighted to announce the release of a new module for our EZ13 Lease Accounting software. The new module tracks Asset Retirement Obligations. While primarily intended to be used for AROs tied to leases, it can also be used for AROs independently.
Asset Retirement Obligations are legal obligations of a company that take effect at the retirement of an asset. Most commonly, they are involved with restoring the asset to its original (pre-use) condition. One common example is cleanup of a drilling site by an oil/gas driller. Another applies to gas stations, which are required to dig up their underground fuel tanks when the station closes (or when the tank reaches the end of its useful life).
Under FAS 143, now called ASC Topic 410-20, a company must estimate the cost of the asset's retirement, most commonly by determining the current cost and applying an inflation factor to get the future cost. (Even if you expect to take care of the work using internal resources, the ARO must be priced based on hiring the work to be done; if you end up actually using internal resources, you will book a gain at that time.) It then books the present value of that cost (using its "credit-adjusted risk-free rate" for borrowing); the asset is called the Asset Retirement Cost, while the liability is the Asset Retirement Obligation. The ARC is depreciated over the remaining life of the asset, while the ARO is accreted over the same life; that is, an interest-type calculation is made on the liability using the same credit-adjusted risk-free rate, and the accretion expense is added to the liability, so that at the end of the asset's life, the ARO is equal to the expected (after-inflation) cost of retirement.
If you have a lease, the ARO's life is normally the same as the lease life. For an owned asset, the ARO life is typically the useful life of the asset itself.
EZ13 now offers complete ARO accounting as an extra-cost module. Reporting available includes showing ARO information on the income statement/balance sheet detail report, ARO accretion/depreciation tables, and rollforward reports (showing beginning balance, additions, accretion/depreciation, terminations, and ending balance, by lease). ARO components with varying levels of probability are accepted. For more details, including an example of an ARO calculation, please see our ARO page.
Asset Retirement Obligations are legal obligations of a company that take effect at the retirement of an asset. Most commonly, they are involved with restoring the asset to its original (pre-use) condition. One common example is cleanup of a drilling site by an oil/gas driller. Another applies to gas stations, which are required to dig up their underground fuel tanks when the station closes (or when the tank reaches the end of its useful life).
Under FAS 143, now called ASC Topic 410-20, a company must estimate the cost of the asset's retirement, most commonly by determining the current cost and applying an inflation factor to get the future cost. (Even if you expect to take care of the work using internal resources, the ARO must be priced based on hiring the work to be done; if you end up actually using internal resources, you will book a gain at that time.) It then books the present value of that cost (using its "credit-adjusted risk-free rate" for borrowing); the asset is called the Asset Retirement Cost, while the liability is the Asset Retirement Obligation. The ARC is depreciated over the remaining life of the asset, while the ARO is accreted over the same life; that is, an interest-type calculation is made on the liability using the same credit-adjusted risk-free rate, and the accretion expense is added to the liability, so that at the end of the asset's life, the ARO is equal to the expected (after-inflation) cost of retirement.
If you have a lease, the ARO's life is normally the same as the lease life. For an owned asset, the ARO life is typically the useful life of the asset itself.
EZ13 now offers complete ARO accounting as an extra-cost module. Reporting available includes showing ARO information on the income statement/balance sheet detail report, ARO accretion/depreciation tables, and rollforward reports (showing beginning balance, additions, accretion/depreciation, terminations, and ending balance, by lease). ARO components with varying levels of probability are accepted. For more details, including an example of an ARO calculation, please see our ARO page.
Thursday, January 26, 2012
LWG favors level expense
Asset Finance International, a European website focused on equipment lessors, is reporting that yesterday's Leases Working Group meeting produced a strong consensus in favor of providing a level expense profile for most leases, as is currently the case for operating leases. While one of the arguments of IASB and FASB board members against this has been that it would mean a different depreciation methodology from owned property, plant, & equipment (PPE), one working group member turned that argument on its head, arguing that this profile would be more appropriate for both leases and owned assets. Obviously, rewriting depreciation rules for owned PPE is out of topic bounds, but changing the rules for leases could be a first step to "start getting it right."
As mentioned in my previous post, the staff presented five alternatives for lease expense profiles. Most LWG members preferred "interest based amortization," which basically subtracts the normally calculated interest expense from what level total expense for that period would be (total expense is generally equal to all rent paid over the life of the lease, which is then equally apportioned over the lease life). For a lease with a single rent step, this would mean that the depreciation per rent payment period would be essentially the same as the principal paid, so asset and liability would be equal throughout the life of the lease. If a lease has multiple rent steps, the difference between asset and liability would be the same as the deferred rent liability currently recognized on leveled operating leases. (The staff document only talks about a simple lease with one rent step; I'm not aware of anyone else pointing out this congruence with current operating lease accounting for multiple rent steps.)
Level expense recognition would not be applied to all leases. The LWG favored defining the dividing line between that and current finance/capital lease expense recognition more or less at the same point that current operating and capital leases are divided: a transfer of control or the lessee's control of "substantially all the remaining benefits" of the leased asset. The wording would be made as consistent as possible with another draft accounting standard on Revenue Recognition.
Level expense recognition would make transition to the new system easier. If all current operating leases are assumed to qualify, there would be no hit either to the income statement or to equity. However, the transition rules would need to be rewritten to specify how the balance sheet should be set up.
The next joint boards meeting is at the end of February, at which the expense profile will be on the agenda. Asset Finance International thinks that the new exposure draft can't come out before May even if the boards don't change the expense profile. If they do, it would likely take a few more months as they review the consequential changes to other parts of the standard. Add a four-month comment period and then time for the boards to redeliberate, and it's likely to be Q4 2012 or even 2013 before the final standard is finally released.
As mentioned in my previous post, the staff presented five alternatives for lease expense profiles. Most LWG members preferred "interest based amortization," which basically subtracts the normally calculated interest expense from what level total expense for that period would be (total expense is generally equal to all rent paid over the life of the lease, which is then equally apportioned over the lease life). For a lease with a single rent step, this would mean that the depreciation per rent payment period would be essentially the same as the principal paid, so asset and liability would be equal throughout the life of the lease. If a lease has multiple rent steps, the difference between asset and liability would be the same as the deferred rent liability currently recognized on leveled operating leases. (The staff document only talks about a simple lease with one rent step; I'm not aware of anyone else pointing out this congruence with current operating lease accounting for multiple rent steps.)
Level expense recognition would not be applied to all leases. The LWG favored defining the dividing line between that and current finance/capital lease expense recognition more or less at the same point that current operating and capital leases are divided: a transfer of control or the lessee's control of "substantially all the remaining benefits" of the leased asset. The wording would be made as consistent as possible with another draft accounting standard on Revenue Recognition.
Level expense recognition would make transition to the new system easier. If all current operating leases are assumed to qualify, there would be no hit either to the income statement or to equity. However, the transition rules would need to be rewritten to specify how the balance sheet should be set up.
The next joint boards meeting is at the end of February, at which the expense profile will be on the agenda. Asset Finance International thinks that the new exposure draft can't come out before May even if the boards don't change the expense profile. If they do, it would likely take a few more months as they review the consequential changes to other parts of the standard. Add a four-month comment period and then time for the boards to redeliberate, and it's likely to be Q4 2012 or even 2013 before the final standard is finally released.
Subscribe to:
Posts (Atom)
