Notes from yesterday's FASB webcast

As previously mentioned, the FASB yesterday offered a one-hour webcast reviewing the proposed new lease accounting standard, for which the Exposure Draft was released in August. The webcast is now available for viewing if you weren't able to view it live (free registration required).

The webcast included both a basic description of the new methodology proposed, and intermittent commentary by Larry Smith, a FASB board member, regarding why particular decisions were made.

On requiring capitalization of options to renew, Mr. Smith said, "The boards wanted to ensure that entities would not structure a one-year lease with additional one-year options to renew with the full intent of a 15-year lease. We wanted to ensure that the lease amounts recorded reflected the true substance of the lease and therefore reflected the likely lease term, which we acknowledge impacts many aspects due to the discounting required. "

Similarly, for contingent rents: "We were concerned with entities in an extreme example having a fixed rent payment of $1, then various contingent and other variable payments which make the monthly expense closer to a million. We wanted to lay out a principle that would capture all expected lease payments to ensure that amounts recorded associated with leases were transparent and inclusive of all lease payments expected."

Obviously the boards are haunted by the structuring that has been common in leasing under FAS 13 (and IAS 17), and are doing everything they can to prevent something like that from happening again. But Mr. Smith says they're open to alternative ways of dealing with the situation; they recognize that they've chosen a method that's complex to implement.

They included preliminary feedback: They feel generally there is agreement with the right-of-use model, but concern about the complexity of contingent rents & determining the lease term, the income statement impact (rather than equal expenses over the life of the lease, depreciation plus interest gives front-end-loaded expenses), differentiating leases from services (and separating service components), applying performance obligation vs. derecognition for lessors, cost/benefit, and doing the transition.

They took questions from viewers of the webcast and answered some. Highlights:

* The boards plan to provide more guidance on distinguishing a service from a lease (and distinct services). They recognize that it will be more significant than it is under FAS 13.
* The FASB plans to consider whether investment property should be accounted for at fair value, as IAS 40 provides (either as an option or mandatory).
* Driving the project is a desire to provide better comparability (eliminating the bright lines between capital and operating leases) and more information to users, who they feel are already attempting to calculate balance sheet impacts on operating leases with limited information.
* While the initial focus was on lessees, they recognized a need to be consistent both between lessees and lessors, and between leasing and the concurrent revenue recognition.
* Mr. Smith: "If we did not provide for including an estimate of contingent rents, leases might be structured very differently to come up with an outcome that would record the minimum asset and liability, and we didn't want to provide those structuring opportunities."
* It is recognized that lessees and lessors will come up with different estimates of lease term, contingent rent, and the like. The lessee most often will probably have better information.

The IASB is also having a webcast, this coming Monday (Nov. 1), at 10 AM and 3 PM GMT. More information is available at the IASB website.

Investors' opportunity to comment

In September, the FASB & IASB invited lessees and lessors to fill out a survey about their leasing activities and how the proposed new lease standard might affect them. Now users of financial statements (investors, lenders, etc.) are given their own opportunity to comment through a survey. You may respond to the 25 questions any time between now and December 15 (which is also when comment letters on the Exposure Draft are due). No prior knowledge of the ED is assumed; summaries of major points are provided, with users asked whether they favor or oppose the decisions made.

FASB webcast discussion Oct. 28

The FASB will be holding a webcast to discuss the proposed new lease accounting standard on Thursday, Oct. 28, 11 AM to noon Eastern time. The webcast will both review the Exposure Draft and discuss initial reactions that the boards have gained from outreach activities that they have recently undertaken.

Anyone may register for free either to watch the webcast live, or to view it from archive after the fact.

What happened to executory costs?

Under FAS 13 accounting, executory costs (expenses such as insurance, taxes, and maintenance) that are billed by the lessor to the lessee are separated out from other rent before a capital lease's rent stream is capitalized. The proposed new standard calls for separating "service components" from the rest of the rent, if they are "distinct" (see exposure draft paragraphs 6 and B5-B8).

It's not clear, though, that "service components" aligns precisely with the old concept of "executory costs." While no doubt maintenance charges would qualify under each term, and probably insurance, what about taxes? Taxes aren't really a service (while one hopes that one gets services for taxes paid, the link is not direct, and failure to receive services is not a justification for not paying). Will this be clarified in the final standard?

Overview of exposure draft

While I've discussed the individual decisions on the lease accounting exposure draft over the last several months as they've been made, it's appropriate to review the proposal in its entirety. I've posted such a review on the FCS web site. I invite you to look there for a summary of the whole proposal.