Thursday, December 30, 2010

The flood of comment letters

As of today, 697 comment letters have been posted responding to the exposure draft on Lease Accounting. The IASB has decided that they couldn't host all the comment letters; instead, you need to go to the FASB's web site to view those numbered 248 and higher (letters 1-247 are available on both sites). Some of the letters were received after the deadline, but have still been accepted.

There are far too many comment letters for me to review them all. But I think it's fair to say that the overwhelming majority object to including renewal options in the calculated lease term using the "more likely than not to be renewed" criterion, and to including most contingent rents in the capitalized rent stream. Many respondents are concerned about the cost of initial and ongoing implementation of the new standard (particularly if lease term and contingent rents need to be estimated and capitalized); many also think the new proposed methodology is inconsistent with their business models. Many are also concerned about the impact of reclassifying rent expense into amortization and interest expense, since the new classification moves the cost out of EBITDA (earnings before interest, taxes, depreciation, and amortization), which is an important metric for many companies. Other concerns expressed include the timing of expense recognition (front-loaded under the new model, as opposed to level under current operating lease accounting), potential for violation of debt covenants because companies will be reporting more debt, difficulty of getting expense reimbursements on cost-based contracts, and volatility of earnings (if the lease term & contingent rent proposals are maintained).

The lessor accounting proposal has varied reactions. Some agree with the proposal. Others think derecognition should be used for all lessor leases. One common complaint about the performance obligation approach is that it leads to double-counting (or even triple-counting) of assets: the lessor maintains the original asset on the books, sets up a lease receivable (another asset), and the lessee recognizes an asset for the right-of-use as well. The impact of double-counting for the lessor is mitigated by the proposal to report PO leases net (receivable minus PO), but it still seems conceptually strange to many people. It is also noted that the PO approach does not mirror lessee accounting.

The volume and vehemence of disagreement raises the bar, in my opinion, on review by the boards. We'll see what comes in the next few months.

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