What will the impact be of capitalizing operating leases, with option periods included? For many retail chains, the tally is literally going to be in the billions of dollars. We've done an analysis for one chain whose liability for capitalized leases will be larger than their entire present current and long-term liabilities (and several times their shareholder equity). The effect of putting an equal amount of assets and liabilities of that magnitude on the balance sheet will be a substantial increase in reported leverage and decrease in important financial ratios. This has important implications for loan covenants and other financial requirements.
It should also be noted that previously reported estimates of the impact of the new standard (such as Georgia Tech's study last year) are likely substantially understated, because they were based on the reported future rent commitments of companies. But those reported commitments exclude most renewal options, which now will have to be included in whole or in part. Many retail store leases have an initial term of 20 years, but then renewal options for as many as 40 more years. Under the new "expected payments" requirement, future rents reported may be double or more what is currently reported, with a commensurate increase in assets & liabilities.
Our EZ13 Lease Accounting software permits you to enter your operating leases for current reporting, but capitalize their remaining rents at a cutover date you specify for pro-forma reports in keeping with the exposure draft of the new lease accounting standard.
Thursday, August 26, 2010
Wednesday, August 25, 2010
FASB Chairman Herz resigns
The chairman of the FASB, Robert Herz, unexpectedly resigned yesterday, effective October 1. There is concern that his departure, and the simultaneous announcement of the Financial Accounting Foundation, the FASB's parent, that the FASB will be increased from 5 to 7 members (undoing a change in 2008), will delay the projects currently underway, including the lease accounting rewrite. The boards have been pushing hard to complete a large number of convergence projects by the end of June 2011, which incidentally is the end of service for the IASB's chairman, Sir David Tweedie. But will FASB want to make all these major decisions with an incomplete board?
Tuesday, August 17, 2010
Lease Accounting Exposure Draft released
The FASB and IASB have released the Exposure Draft of the proposed new lease accounting standard (FASB topic 840 in the new Accounting Standards Codification). The FASB has made the ED available here. The IASB has posted the ED, an accompanying Basis for Conclusions (which the FASB has bundled with the ED), a Snapshot Summary, and a Press Release.
The comment deadline is December 15, 2010. The FASB invites people to send comments by email to director@fasb.org, File Reference No. 1850-100. The IASB asks for submissions on their web page. As with the Preliminary Views document last year, the comment letters sent to both boards will be combined for the boards' review (and it is not necessary to send a comment letter both places).
I will post a review of the ED here in coming days, though there shouldn't be any real surprises; this is just a restatement of the decisions made over the last year, which have been reviewed as they happened in earlier posts on this blog. As with the Preliminary Views document, I expect to review the ED section by section.
The comment deadline is December 15, 2010. The FASB invites people to send comments by email to director@fasb.org, File Reference No. 1850-100. The IASB asks for submissions on their web page. As with the Preliminary Views document last year, the comment letters sent to both boards will be combined for the boards' review (and it is not necessary to send a comment letter both places).
I will post a review of the ED here in coming days, though there shouldn't be any real surprises; this is just a restatement of the decisions made over the last year, which have been reviewed as they happened in earlier posts on this blog. As with the Preliminary Views document, I expect to review the ED section by section.
Monday, August 16, 2010
Exposure Draft imminent; live webcast discussion August 18
The IASB has scheduled a live webcast on August 18 to present the Exposure Draft of the new lease accounting standard. The webcast will include a Q&A time. They're holding the same event twice, to have it at times that are reasonable in more time zones: 10:30 am & 3:30 pm London time, which is 5:30 am & 10:30 am Eastern Daylight Time in the U.S. You may register for either at the IASB web site. I presume the Exposure Draft itself will be out before the webcast, but I see no sign that it has yet been released.
Friday, July 30, 2010
Final decisions before the Exposure Draft
At the FASB & IASB meetings July 19, 21, and 22, the boards reached the following decisions for the new lease accounting standard:
Scope & sale/leaseback accounting
Previously, the boards had set several criteria that would indicate a transaction should be considered a sale/purchase rather than a lease. These had the effect of converting many currently capital leases into purchases. The boards have now retreated somewhat from that position, by removing two criteria:
1. The contract covers the whole of the expected useful life of the asset.
2. The contract specifies a fixed return to the transferor.
The boards reaffirmed treatment as a purchase/sale if, at the end of the contract, control of the underlying asset and all but a trivial amount of the risks and benefits associated with that asset are transferred to the recipient. This requirement must be met for sale/leaseback accounting to be permitted.
Lessor accounting: performance obligation vs. derecognition
A lessor that retains exposure to significant risks and benefits associated with the underlying asset should apply the performance obligation approach; if no significant exposure remains, the derecognition approach is to be used. The risks and benefits may be during the expected term, or subsequent to the term (such as the expectation of re-leasing or selling the asset). Counterparty credit risk is not to be considered. The assessment is to be made at the beginning of the lease and not subsequently reassessed.
Risks & benefits during the lease term include: significant contingent rentals based on use or performance of the underlying asset, options to extend or terminate, and material nondistinct services provided. Risks & benefits subsequent to the lease contract include: whether the lease term is short in relation to the useful life of the asset, and whether a significant change in the value of the asset is expected (including the effect of .
In deciding which approach to use, a lessor must include third-party residual guarantees in determining whether the lessor is exposed to significant risks and benefits. (It had been suggested that these should be considered as insurance contracts separate from the lease agreement and not affecting the approach decision; this is now discarded.)
Lessor accounting: leases with service components
The boards disagreed. The majority of the FASB thought that nondistinct services should not be bifurcated from the lease component under derecognition. The majority of the IASB took the opposite view, with the service element to be accounted for in accordance with the new revenue recognition standard. The FASB majority thought that if bifurcation was done, the service element should give rise to a receivable and performance obligation. Presumably both approaches will be presented in the upcoming Exposure Draft.
Exposure draft release
The boards plan to release the Exposure Draft of the proposed new lease accounting standard during the week of August 9. This will restate, in the form of a standard, the various decisions that they've made over the last 9 months. Anyone is invited to submit a comment letter for the boards to review. Some decisions clearly remain to be made, since the boards have disagreed on a few issues, and they're trying to reach a converged standard. And everything so far is couched as "tentatively decided," so in theory everything is subject to alteration. Realistically, though, it is unlikely that the broad outlines of the new standard, particularly placing all leases on the balance sheet, will change.
Scope & sale/leaseback accounting
Previously, the boards had set several criteria that would indicate a transaction should be considered a sale/purchase rather than a lease. These had the effect of converting many currently capital leases into purchases. The boards have now retreated somewhat from that position, by removing two criteria:
1. The contract covers the whole of the expected useful life of the asset.
2. The contract specifies a fixed return to the transferor.
The boards reaffirmed treatment as a purchase/sale if, at the end of the contract, control of the underlying asset and all but a trivial amount of the risks and benefits associated with that asset are transferred to the recipient. This requirement must be met for sale/leaseback accounting to be permitted.
Lessor accounting: performance obligation vs. derecognition
A lessor that retains exposure to significant risks and benefits associated with the underlying asset should apply the performance obligation approach; if no significant exposure remains, the derecognition approach is to be used. The risks and benefits may be during the expected term, or subsequent to the term (such as the expectation of re-leasing or selling the asset). Counterparty credit risk is not to be considered. The assessment is to be made at the beginning of the lease and not subsequently reassessed.
Risks & benefits during the lease term include: significant contingent rentals based on use or performance of the underlying asset, options to extend or terminate, and material nondistinct services provided. Risks & benefits subsequent to the lease contract include: whether the lease term is short in relation to the useful life of the asset, and whether a significant change in the value of the asset is expected (including the effect of .
In deciding which approach to use, a lessor must include third-party residual guarantees in determining whether the lessor is exposed to significant risks and benefits. (It had been suggested that these should be considered as insurance contracts separate from the lease agreement and not affecting the approach decision; this is now discarded.)
Lessor accounting: leases with service components
The boards disagreed. The majority of the FASB thought that nondistinct services should not be bifurcated from the lease component under derecognition. The majority of the IASB took the opposite view, with the service element to be accounted for in accordance with the new revenue recognition standard. The FASB majority thought that if bifurcation was done, the service element should give rise to a receivable and performance obligation. Presumably both approaches will be presented in the upcoming Exposure Draft.
Exposure draft release
The boards plan to release the Exposure Draft of the proposed new lease accounting standard during the week of August 9. This will restate, in the form of a standard, the various decisions that they've made over the last 9 months. Anyone is invited to submit a comment letter for the boards to review. Some decisions clearly remain to be made, since the boards have disagreed on a few issues, and they're trying to reach a converged standard. And everything so far is couched as "tentatively decided," so in theory everything is subject to alteration. Realistically, though, it is unlikely that the broad outlines of the new standard, particularly placing all leases on the balance sheet, will change.
Friday, June 25, 2010
Leases in business acquisitions
Under FAS 13, if a business acquires another business that has capital leases, the lease is re-evaluated. The present value of the rents is the new obligation, while the asset is booked at fair value, which may be a different amount.
The FASB has decided, in a June 23 meeting, that this will no longer be the case. Instead, under the new lease accounting standard, an acquirer will account for the lease as if it were a new lease starting on the day of acquisition, and otherwise account for it as any other lease.
A rare win for simplification as part of the lease accounting revision...
The FASB has decided, in a June 23 meeting, that this will no longer be the case. Instead, under the new lease accounting standard, an acquirer will account for the lease as if it were a new lease starting on the day of acquisition, and otherwise account for it as any other lease.
A rare win for simplification as part of the lease accounting revision...
Derecognition over performance obligation (sometimes)
The FASB & IASB, in meetings June 16 & 17, decided to partially pull back from the concept of a performance obligation for lessors in the new lease accounting standard. They have now decided to use that approach (where the original leased assets remains on the lessor's books untouched, and a matching receivable debit and performance obligation credit are set up for the lessor lease, with the receivable amortized using the interest method and the performance obligation amortized straight-line) only for leases "that expose the lessor to significant risks and benefits associated with the underlying asset." In other cases, a derecognition approach is to be used: Once the receivable is calculated for the lessor lease, the owned asset is credited for that amount. The IASB staff commented that this is similar to the current distinction between operating and capital leases (wasn't the goal of the new standard to get away from that?).
The vote was actually split between the boards, with the IASB in favor of this hybrid approach, while a majority of the FASB prefers performance obligations for all leases. However, the FASB Action Alert summary states that "the Boards" decided on the hybrid approach, which suggests that in the interests of convergence, either the IASB has priority or the vote is being tallied in total. I don't know enough about the workings of the convergence project to clarify that.
Other topics covered:
Lessor transition under a derecognition approach
The boards have decided that lessors should recognize a lease receivable at the present value of the remaining lease paymentss, and a residual asset at fair value. The present value is based on the implicit rate at lease inception, but it looks like that includes the residual asset at its current, not original, estimate of future value.
Leases with a service component, lessor derecognition
The boards were unable to come to a conclusion for how to account for leases that include a service component (what is called executory costs under the current leasing standards), when the services and leases are not distinct, for a lessor lease involving derecognition. This will be discussed further in July.
Purchase options
Purchase options are to be accounted for only upon exercise (aside from bargain purchase options, which immediately turn it into an in-substance purchase). This applies to both lessees and lessors.
Retirement of IASB members
Gilbert Gelard, Robert Garnett, and James Leisenring are retiring from the IASB as of June 30. Jim Leisenring has been a particularly forceful voice on the board. He's a former member of the FASB as well, and does not hesitate to make his views known. The impact of the change in personnel remains to be seen.
The vote was actually split between the boards, with the IASB in favor of this hybrid approach, while a majority of the FASB prefers performance obligations for all leases. However, the FASB Action Alert summary states that "the Boards" decided on the hybrid approach, which suggests that in the interests of convergence, either the IASB has priority or the vote is being tallied in total. I don't know enough about the workings of the convergence project to clarify that.
Other topics covered:
Lessor transition under a derecognition approach
The boards have decided that lessors should recognize a lease receivable at the present value of the remaining lease paymentss, and a residual asset at fair value. The present value is based on the implicit rate at lease inception, but it looks like that includes the residual asset at its current, not original, estimate of future value.
Leases with a service component, lessor derecognition
The boards were unable to come to a conclusion for how to account for leases that include a service component (what is called executory costs under the current leasing standards), when the services and leases are not distinct, for a lessor lease involving derecognition. This will be discussed further in July.
Purchase options
Purchase options are to be accounted for only upon exercise (aside from bargain purchase options, which immediately turn it into an in-substance purchase). This applies to both lessees and lessors.
Retirement of IASB members
Gilbert Gelard, Robert Garnett, and James Leisenring are retiring from the IASB as of June 30. Jim Leisenring has been a particularly forceful voice on the board. He's a former member of the FASB as well, and does not hesitate to make his views known. The impact of the change in personnel remains to be seen.
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