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.)
Thursday, July 30, 2009
Friday, July 24, 2009
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.
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.
Thursday, July 23, 2009
EZ13 v2.3 released
FCS is delighted to announce the release of version 2.3 of EZ13(TM), the Lease Accounting solution. (The new version was actually released over a month ago, but I forgot to post this announcement.) This latest release includes a wide range of new features:
Contingent rent: EZ13 has a new tab for contingent rent, which is rent paid that is not part of the FAS 13 minimum lease payments. Contingent rent is expensed as incurred. You can enter contingent rent in the screen tab, or upload it using an Excel® spreadsheet (requires Excel installed on your computer). (Not in Mini Edition.)
Rent escalation: EZ13 can automatically create a series of rent steps based on a periodic escalation calculation (increasing by 10% every 5 years, or 5% compounded per year, etc.). This complements the existing automatic calculation of rent for leases with level principal amortization.
Expirations report: Get a list of leases scheduled to expire between two dates.
Transfer additions and terminations: A transfer addition picks up the asset and obligation midstream for the lease; a transfer termination is almost the same as an early termination, but is designed to match a transfer addition. These are useful if a lease is being moved from one department to another, and you want to recognize the expenses up to a certain date as belonging to one account and afterwards to another (using EZ13’s account numbers feature or other distinguishing codes).
Month to month extensions: Sometimes leases are renewed after expiration on a month to month basis. There is no future rent commitment; rent is expensed as incurred (using the contingent rent feature noted above). You can optionally leave the gross asset and accumulated depreciation on the books (assuming the lease is depreciated over the lease term, the gross asset and accumulated depreciation are equal, so the net asset is zero).
Capitalize leases at incremental borrowing rate (not in Lite or Mini Editions): EZ13 has had the capability to treat operating leases as capital, using their incremental borrowing rate as the capital rate. This is intended both for current indenture reporting that some lenders require, and in anticipation of the upcoming rewrite of the lease accounting standard, which plans to capitalize all operating leases at the incremental rate. The current draft of the upcoming standard calls for all leases, including those currently capital, to use the incremental rate; there would be no limitation of the asset value to the fair market value of the underlying asset, which currently causes some capital leases to have higher interest rates. This new option lets you see the effect on your capital leases of the FASB/IASB proposal. (See prior blog entries for more information on the FASB/IASB proposed rewrite of lease accounting standards.)
Some of the feature additions were in response to requests from users of EZ13. We will continue to provide updates (at least one per year) with enhanced features at no additional cost to clients who maintain a support contract. Updated CDs are being sent to all such clients. Any clients who have not maintained their support contract can get the update by reinstating support; contact us for details.
The free demo available for download on our website has been updated to v2.3, so you can try out the new features yourself.
Contingent rent: EZ13 has a new tab for contingent rent, which is rent paid that is not part of the FAS 13 minimum lease payments. Contingent rent is expensed as incurred. You can enter contingent rent in the screen tab, or upload it using an Excel® spreadsheet (requires Excel installed on your computer). (Not in Mini Edition.)
Rent escalation: EZ13 can automatically create a series of rent steps based on a periodic escalation calculation (increasing by 10% every 5 years, or 5% compounded per year, etc.). This complements the existing automatic calculation of rent for leases with level principal amortization.
Expirations report: Get a list of leases scheduled to expire between two dates.
Transfer additions and terminations: A transfer addition picks up the asset and obligation midstream for the lease; a transfer termination is almost the same as an early termination, but is designed to match a transfer addition. These are useful if a lease is being moved from one department to another, and you want to recognize the expenses up to a certain date as belonging to one account and afterwards to another (using EZ13’s account numbers feature or other distinguishing codes).
Month to month extensions: Sometimes leases are renewed after expiration on a month to month basis. There is no future rent commitment; rent is expensed as incurred (using the contingent rent feature noted above). You can optionally leave the gross asset and accumulated depreciation on the books (assuming the lease is depreciated over the lease term, the gross asset and accumulated depreciation are equal, so the net asset is zero).
Capitalize leases at incremental borrowing rate (not in Lite or Mini Editions): EZ13 has had the capability to treat operating leases as capital, using their incremental borrowing rate as the capital rate. This is intended both for current indenture reporting that some lenders require, and in anticipation of the upcoming rewrite of the lease accounting standard, which plans to capitalize all operating leases at the incremental rate. The current draft of the upcoming standard calls for all leases, including those currently capital, to use the incremental rate; there would be no limitation of the asset value to the fair market value of the underlying asset, which currently causes some capital leases to have higher interest rates. This new option lets you see the effect on your capital leases of the FASB/IASB proposal. (See prior blog entries for more information on the FASB/IASB proposed rewrite of lease accounting standards.)
Some of the feature additions were in response to requests from users of EZ13. We will continue to provide updates (at least one per year) with enhanced features at no additional cost to clients who maintain a support contract. Updated CDs are being sent to all such clients. Any clients who have not maintained their support contract can get the update by reinstating support; contact us for details.
The free demo available for download on our website has been updated to v2.3, so you can try out the new features yourself.
Wednesday, July 8, 2009
Additional decisions on lessee accounting
At meetings held June 17 and June 18, the FASB and IASB (respectively) discussed additional lease accounting issues that were not covered in the Preliminary Views discussion paper. The following topics were discussed and conclusions reached:
Sale and leaseback transactions
An asset (most commonly real estate) may be sold and immediately leased back. FAS 98 has an extensive set of tests to determine whether the continuing involvement of both seller/lessee and buyer/lessor are such that the transaction should be recognized as a sale and a lease, or as a financing that doesn’t meaningfully transfer the asset, so that it would remain on the books of the putative seller/lessee. Sale/leasebacks are sometimes done for cash flow purposes; at other times, a major purpose under current accounting may be off-balance sheet financing. With the end of operating lease accounting under the new rules, the latter purpose would disappear.
The boards decided that in a sale/leaseback, the entire asset should be derecognized and replaced with a right-to-use asset (rather than keeping a portion of the original asset on the seller/lessee’s books). The IASB concluded that a gain should be recognized immediately; the FASB’s meeting summary doesn’t indicate their decision. The FASB thinks there may be a need for additional guidance when the sale price or rental payments aren’t at market rates.
Impairments
Existing general accounting standards for impairments should also be used for lease right-to-use assets. This means that US lessees would use FAS 144, while IFRS users would use IAS 36, consistent with their treatment of impairments of other assets.
Revaluation
The FASB holds that revaluation of the right-to-use asset would reflect amortization and impairment. Adjusting based on fair value would generally not be permitted. The IASB refers to revaluation models in IAS 16 for property, plant, & equipment, and IAS 38 for intangible assets, which do permit revaluing based on fair value.
Initial direct costs
Initial direct costs for negotiating and arranging leases are to be expensed as incurred.
Transition
This was a big hole in the preliminary views document. Both boards agreed that leases should be set up using the remaining rents as of the date of application of the new standard, valuing the obligation at the present value of the rents (using the current incremental borrowing rate), and setting the asset to the same value (the IASB notes that there could be an impairment adjustment).
Nothing, however, is said about how to handle the existing deferred liabilities on existing operating leases with scheduled rent increases, or the difference between asset and liability on existing capital leases. Will this be taken directly to retained earnings, or recognized as a gain or loss in the income statement? Most lessees would probably prefer to recognize the change in the income statement, because almost all leases (leveled operating and capital) would show a gain on removal. The argument would be that they have in effect over-expensed these leases, so they should be able to recover that excess expense as part of the changeover.
Next steps
The discussion paper comment period closes a week from Friday, July 17. The boards plan to discuss the comments at meetings in September. In July there will be another meeting to discuss additional matters related to lessor accounting (following up their May meeting); I haven’t seen a specific date yet. The two boards will be holding joint meetings on July 23 & 24, but I don’t see any indication whether they will take that time to discuss leases, or will continue their more typical practice of meeting separately to discuss the issues.
Sources for board information:
IASB meeting summary: http://www.iasb.org/Current+Projects/IASB+Projects/Leases/Meeting+Summaries+and+Observer+Notes/IASB+June+2009.htm
IASB meeting audio: http://www.iasb.org/Current+Projects/IASB+Projects/Leases/Meeting+Audio+Playback/Meeting+Audio+Playback.htm
IASB meeting agenda papers: http://www.iasb.org/Meetings/IASB+Board+Meeting+18+June+2009.htm
FASB meeting summary: http://www.fasb.org/leases.shtml
Meeting handout: http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176156247551
Sale and leaseback transactions
An asset (most commonly real estate) may be sold and immediately leased back. FAS 98 has an extensive set of tests to determine whether the continuing involvement of both seller/lessee and buyer/lessor are such that the transaction should be recognized as a sale and a lease, or as a financing that doesn’t meaningfully transfer the asset, so that it would remain on the books of the putative seller/lessee. Sale/leasebacks are sometimes done for cash flow purposes; at other times, a major purpose under current accounting may be off-balance sheet financing. With the end of operating lease accounting under the new rules, the latter purpose would disappear.
The boards decided that in a sale/leaseback, the entire asset should be derecognized and replaced with a right-to-use asset (rather than keeping a portion of the original asset on the seller/lessee’s books). The IASB concluded that a gain should be recognized immediately; the FASB’s meeting summary doesn’t indicate their decision. The FASB thinks there may be a need for additional guidance when the sale price or rental payments aren’t at market rates.
Impairments
Existing general accounting standards for impairments should also be used for lease right-to-use assets. This means that US lessees would use FAS 144, while IFRS users would use IAS 36, consistent with their treatment of impairments of other assets.
Revaluation
The FASB holds that revaluation of the right-to-use asset would reflect amortization and impairment. Adjusting based on fair value would generally not be permitted. The IASB refers to revaluation models in IAS 16 for property, plant, & equipment, and IAS 38 for intangible assets, which do permit revaluing based on fair value.
Initial direct costs
Initial direct costs for negotiating and arranging leases are to be expensed as incurred.
Transition
This was a big hole in the preliminary views document. Both boards agreed that leases should be set up using the remaining rents as of the date of application of the new standard, valuing the obligation at the present value of the rents (using the current incremental borrowing rate), and setting the asset to the same value (the IASB notes that there could be an impairment adjustment).
Nothing, however, is said about how to handle the existing deferred liabilities on existing operating leases with scheduled rent increases, or the difference between asset and liability on existing capital leases. Will this be taken directly to retained earnings, or recognized as a gain or loss in the income statement? Most lessees would probably prefer to recognize the change in the income statement, because almost all leases (leveled operating and capital) would show a gain on removal. The argument would be that they have in effect over-expensed these leases, so they should be able to recover that excess expense as part of the changeover.
Next steps
The discussion paper comment period closes a week from Friday, July 17. The boards plan to discuss the comments at meetings in September. In July there will be another meeting to discuss additional matters related to lessor accounting (following up their May meeting); I haven’t seen a specific date yet. The two boards will be holding joint meetings on July 23 & 24, but I don’t see any indication whether they will take that time to discuss leases, or will continue their more typical practice of meeting separately to discuss the issues.
Sources for board information:
IASB meeting summary: http://www.iasb.org/Current+Projects/IASB+Projects/Leases/Meeting+Summaries+and+Observer+Notes/IASB+June+2009.htm
IASB meeting audio: http://www.iasb.org/Current+Projects/IASB+Projects/Leases/Meeting+Audio+Playback/Meeting+Audio+Playback.htm
IASB meeting agenda papers: http://www.iasb.org/Meetings/IASB+Board+Meeting+18+June+2009.htm
FASB meeting summary: http://www.fasb.org/leases.shtml
Meeting handout: http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176156247551
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