Fighting on the expense profile

According to a Wall Street Journal article in yesterday's edition (available online only by subscription), most companies are resigned to the new lease accounting standard putting leases on the balance sheet. The primary issue they're pushing back on is the front-loading of expenses (which happens because interest is higher in the early years of a repayment schedule, while the depreciation remains straight-line throughout the lease term). The boards briefly considered, then rejected, a proposal earlier this year to make the expense profile straight-line by making the depreciation expense equal to the obligation repayment in each payment period; they didn't like the way the depreciation would look, and felt it was inconsistent with other aspects of accounting.

However, the topic hasn't died, and the article says that the FASB & IASB staff plan to revisit the issue with the boards, perhaps next month.

The article notes that the front-loaded profile is particularly problematic for retailers, who typically have lower revenues in the first years a store is open. Chains that are rapidly opening up new stores would be especially hard hit. The article indicates that investors also consider the expense front-loading unhelpful.

The article speculates that companies might shorten the life of their leases to reduce the impact of front-loading, but notes that that could cause problems for landlords who depend on long-term leases to guarantee their loans.

In other news, I realized I missed commenting on a November 1 meeting:

The boards worked through lessor disclosures, including:

• A table of all lease related income items, listing separately profit at lease commencement, interest income on the receivable, interest income on the residual, variable payments, and short-term lease income.
• Information about variable lease terms, renewal options, and purchase options
• A reconciliation of the right to receive payments and residual assets (showing beginning balance, additions, payments or residual accretion, terminations, and ending balance)
• A maturity analysis of future rent payments, by year for at least five years with the remainder as a lump sum
• Information about how the lessor manages risks on the underlying asset

The boards decided that a lessor doesn't need to disclose:

• Initial direct costs
• The weighted average or range of interest rates on leases
• "Fair values" of the receivable or residual (a term of art that requires determining a market price for sale)

Sale/leaseback transition

• An existing sale/leaseback transaction that resulted in a capital/finance lease will continue to be accounted for with no adjustments.
• A sale/leaseback with an operating lease or with no recognition of sale would be reevaluated based on the criteria for transfer of control of an asset in the proposed revenue standard (which presumably will be finalized no later than the leases standard; its exposure draft was put out Nov. 14). If met, the lease would transition like other operating leases.

Additionally, the FASB clarified that an exception from lease accounting under EITF 01-8, applicable to certain transactions entered into before May 2003, will not be retained, and such transactions will need to be accounted for as leases under the new standard.