Thursday, May 17, 2012

Outreach results on expense recognition

At their February meeting, as previously reported, the FASB & IASB were split regarding the proper approach to expense recognition for leases under the new standard. They directed the staffs to do outreach, meeting with a total of nearly 200 preparers (companies and organizations that prepare financial statements), users (banks and analysts that use financial statements for investing and lending decisions), lessors, and auditors.

That work is now complete, and the boards will review the results at a meeting next Thursday, May 24. The summary is available online. Highlights:

The staff presented four options for reporting expenses:
Approach A: Identical to current capital/finance lease accounting: Interest expense calculated on the remaining liability balance, with depreciation expense recognized usually straight line.
Approach B:  Interest expense as in Approach A. Officially the remaining asset would be the present value of the remaining benefits, with depreciation the difference between the remaining asset at the beginning and end of the period. If remaining benefits are considered to be equal throughout the life of the lease, and rent payments are also equal, depreciation plus interest in any given period would be equal to the rent (and equal over the life of the lease). This was described as "interest-based amortization" at the February meeting.
Approach C:  Interest expense as in Approach A. Depreciation is based on considering the estimated consumption of the underlying asset over the lease term. For a real estate lease whose property is expected to be worth as much or more at the end of the lease, depreciation would equal principal repayment, and the total expense would give a result similar to operating lease accounting. For an equipment lease whose property is completely used up during the lease, the result would be the same as Approach A. A lease in between would get a proportionate result. This was described as the "underlying asset approach" at the February meeting.
Approach D: This was not discussed at the February meeting. A single lease expense item would be reported, equal to the straight-line rent. It is not clear how the asset and liability would be calculated for balance sheet purposes (I believe liability would be the same as for other approaches, but I've seen no indication of how the journal entries would work for it or for the asset amortization).

Nearly all users reported that they attempt to capitalize lessees' operating leases currently to get a better picture of a company's financial situation. However, they had a variety of methods of doing so, on both the balance sheet and the income statement sides. There's no way to provide matching results for everyone.

Most users thought a single model for all leases would be best, though they recognize that people lease for different reasons. Most preferred either Approach A or Approach D.

Most thought Approaches A & D would be least costly and difficult to apply. Some thought that C would be prohibitively costly; some retail lessees reported having over 15,000 leases that are regularly renegotiated, which they considered would make reassessing the consumption pattern impracticable. Preferences were often influenced by the type of leasing a preparer did: retail lessees tended to prefer D while oil & gas lessees preferred A. Some argued, though, that D would call into question recognizing the leases on the balance sheet.

There was no agreement on whether symmetry between lessee and lessor accounting was critical, though it was noted that a lack of symmetry could make sublease accounting "anomalous." Lessors said they would not always be able to provide information to lessees regarding valuations (residual values, etc.), because that is sometimes confidential for competitive reasons. While they find the receivable and residual model proposed for lessors to be appropriate for assets that are leased just once or twice, they find it less appropriate for longer-lived assets that are leased multiple times to different lessees, and would prefer current operating lease accounting for such transactions.

Some have questioned whether Approach C in particular is auditable. Auditors believe it is, but that it would be the most costly approach to audit (and for preparers to implement). They also question how to test and account for impairments under B and D because of the unusual method of calculating the net asset.

We'll see if the boards can reach a consensus at next week's meeting. It's not outside the realm of possibility that they'll punt the issue, offering more than one alternative in the revised exposure draft and asking for responses, making the final decision during redeliberation.

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