Monday, September 23, 2013

Comments, comments, comments

They all came in a flood at the last minute. Comment letters to the proposed new lease accounting standard were due September 13; while a few are trickling in late (including from such major companies as General Electric and Société Générale), the final count will probably end up being very close to the current number of 579. That's substantially less than the 786 that were submitted in response to the first exposure draft, but it'll still mean a lot of slogging for the staff to read through them all and pull out both common themes and specific comments and ideas.

My comment letter is number 439.

Almost nobody, from those I've read, likes the proposal as written. However, the parts that concern them vary, and in many cases the proposed solutions are contradictory to each other. A major common theme is that the proposal is too complex and expensive to implement. Another major theme is that the proposal is conceptually flawed, and that the accounting (particularly Type B lessee accounting) is being driven to accomplish a particular result, rather than because it is consistent with general accounting principles.

A number of companies are asking for extended time to implement if the proposal is approved as a final standard--I've seen requests for as much as five years. That seems unlikely, but the number of companies saying that two years is not enough may well force the boards to go more slowly, suggesting that implementation, even without major changes, may wait for 2018. And the chance for major changes is seeming significant.


  1. Thank you for the update. I've been following your blog on the proposed lease accounting changes and have found it to be very helpful, particularly in providing a concise view of the impacts of the proposed changes. I am curious as to your view, if you have one, on the impact the proposed changes would have on the real estate "synthetic lease" structure, and in particular the treatment of the lessee's residual value guarantee in determining the lease payments that must be included for discounting to PV for calculating the Type B Lease Liability. On the surface, it looks like you would only include the portion of the RVG that the lessee expects to pay. Assuming the lessee would leave occupancy of the property, that amount would be the shortfall (if any) between the expected residual value of the (empty) property and the lease balance (original capitalized cost). I suppose one could argue, however, that it would be very unlikely for a lessee to pay any RVG amount and walk away from the property (particularly in the case of a build-to-suit specifically tailored for the lessee's needs), as opposed to electing the purchase option, buying the property back, and then utilizing a sale-leaseback or other financing going forward. This logic, however, might lead to the conclusion that exercising the purchase option is economically compelling, and conceivably result in having to include the purchase option price in the lease payments that are discounted to determine the Lease Liability (and therefore, the Right of Use Asset). Another potential pitfall for someone considering a synthetic lease under current GAAP would seem to be that if the proposed new rules were implemented during the term of that lease and the RVG were substantial, the resulting straight-line single lease expense (incorporating an amortization of the ROU Asset) could be much higher (i.e., a much greater negative impact on earnings) than the straight-line rent expense under current GAAP. Your thoughts?

    1. I presume your concern is with leases entered into before the new standard takes effect, since after that date the reason for doing a synthetic lease structure (keeping the lease operating for book, but capital for tax) will go away.

      Yes, the current proposal calls for including only the portion of the RVG that the customer expects to pay (unlike FAS 13, which requires including the entire RVG in the minimum lease payments, assuming that purchasing the asset isn't economically compelled). RVG vs. exercising the purchase option would be a judgment call to make; if you're in a declining market when the lease expires, a company might cut its losses by meeting the RVG rather than a purchase option.

      I think you're right that the Type B Single Lease Expense, could be considerably higher than traditional rent leveling if there's a significant RVG, since that typically isn't counted in leveling operating rent under FAS 13, but it would be counted as part of the lease liability under Type B accounting. Again, though, you only have to count what you expect to pay; I would think the normal expectation is that there would be no guarantee payout.

    2. Yes, the concern is with a potential synthetic lease entered into prior to implementation and how it is transitioned. Thanks for your insights. In practical terms under these synthetic leases, it is generally understood by the lessee that the way out of the lease is to either negotiate an extension with lenders, or trigger the purchase option. In most cases, the lessee would still want to occupy the property, so paying out under the RVG is not really an option. Do you think that this built-in expectation of exercising the purchase option would or should cause the lessee to include the purchase option price in the Lease Liability, or even classify it as a Type A lease at the time of implementation?

    3. (You only need to post your comment once. You're not seeing it immediately because I've had to turn on moderation of comments; I was getting too much spam.)

      According to the 2013 Exposure Draft, a purchase option should be recognized, and Type A accounting used, "if a lessee has a significant economic incentive to exercise" the option. You need to consider "contract-based, asset-based, entity-based and market-based factors" to determine whether there is a "significant economic incentive." This includes costs related to moving, location, and the like. Since this is a judgment call, the previous safe harbor of keeping a dollar below the 90% test and a day short of the 75% test goes away. I think it's quite likely in the scenario you describe that auditors would say that Type A accounting is required, either considering that the purchase option has to be recognized (which results in automatic Type A classification) or that including the RVG in the lease payments provides a return to the lessor of "substantially all of the fair value." "Substantially all" is intentionally left undefined, but IFRS reporting uses it for current capital vs. operating testing, and I know that customers of ours who have moved from FAS 13 to IFRS reporting (because they were bought by an international company, or they are in Canada which switched to IFRS a couple of years ago), have sometimes had to reclassify operating leases as capital. I'm sure some sorting out of new terminology will be required whenever the new standard is finalized.