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.