Implementation guidance, straight from the source

Both the IASB and the FASB have announced webinars to assist preparers in implementing the new lease accounting standards. The IASB has just posted a web presentation on The Transition to IFRS 16 (focused on transitioning operating leases, and primarily using the cumulative catch-up approach, rather than full retrospective application), along with additional transition/implementation materials available (and soon to be released) shown here.

The FASB will have a webinar on ASC 842 on Tuesday, March 29, 2016, 1-2 PM Eastern time. 1.0 CPE credit hours are offered for CPAs who register. These webinars are typically archived for later viewing, though CPE credit is not available then.

Summary of ASC 842

A nearly 10-year process is complete. The FASB and IASB announced in July 2006 that they would undertake a comprehensive review of lease accounting. the primary purpose was to end the off-balance-sheet status of lessee operating lease accounting, but the boards also wanted to converge their standards, and review other aspects of lease accounting. The original target date for completion was 2009, but it took a Discussion Paper, two Exposure Drafts, over 1700 comment letters, and hundreds of meetings with users and preparers of financial statements, associations of lessees and lessors, accountants, and various other interested parties to finally reach the final document, published by the IASB as IFRS 16 and the FASB as ASC 842. The final result is not converged in some important aspects; most significantly, the IASB has chosen to require all leases to be treated as finance leases, while the FASB is keeping a finance vs. operating distinction for purposes of calculating the expenses (usually recognized straight-line) and asset (equal to the liability for simple leases).

The following is a summary of the most important points, with a particular emphasis on what’s changed from FAS 13. (I will make a later post discussing the significant differences of IFRS 16.)

Lessee operating leases on the balance sheet

All leases with a non-cancelable term of more than 12 months must be capitalized and recognized on the balance sheet (or Statement of Financial Position, to use FASB’s preferred terminology). The liability is calculated as the present value of the remaining rents; the interest rate used is the lease’s implicit rate, if known, otherwise the lessee’s incremental borrowing rate. The asset is calculated starting from the liability, then adjusted by adding any initial direct costs, subtracting lease incentives and impairments, and adding any difference between cash and leveled rent; all these items are amortized straight-line.

What rent is capitalized

The old concept of “executory costs,” which are not capitalized because they don’t reflect recovery of the cost of the asset itself, has been replaced with “nonlease components.” Nonlease components represent payments made which transfer a good or service to the lessee. So charges for a service contract or common area maintenance (CAM) are both executory costs and nonlease components. Charges for taxes and insurance (such as in a gross property lease) are executory costs currently, but do not qualify as nonlease components, and therefore must be included in the capitalized rent.
Land and building leases still qualify for separated treatment, with the land usually not a finance lease. However, the assignment of rent is now proportional to the fair values of the land and building assets, rather than the land rent being calculated based on the incremental borrowing rate.

Classification

While the terminology has changed slightly—FAS 13 capital leases are now called “finance leases,” because all leases are capitalized—the tests to distinguish finance from operating leases are essentially unchanged. While ASC 842-10-25-2 uses “principles” language for the tests (“the lease term is for the major part of the remaining economic life”; “the present value of the … lease payments … equals or exceeds substantially all of the fair value”), 842-10-55-2 says that “one reasonable approach” is to use the 75% and 90% thresholds. We can expect virtually all U.S. preparers to stick with those tried-and-true methods. There is one additional test: “The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.” (In such situations, one would expect the lessor to fully recover his investment during the lease, so one of the previous tests would almost certainly be met as well, making the additional test probably insignificant.)

Leases with a non-cancelable term of 12 months or less (including renewal options that are considered reasonably certain of being exercised) may be excluded from capitalization, but their costs (excluding leases with a term of a month or less) must be separately disclosed.
 
Lessors: Leveraged leases have been eliminated (though existing leveraged leases are grandfathered). The distinction between sales-type and direct financing is no longer whether the fair value and carrying amount of the asset are equal, but whether the present value test is met via the rent & residual due from the lessee vs. a third-party guarantee of residual value. A sales-type lease permits immediate recognition of profit; a direct financing lease recognizes the profit from the difference between the fair value and carrying amount though interest income over the life of the lease.

Lessee reporting requirements

Finance leases create an asset and liability, as with current capital leases. The “right of use” asset is depreciated like other PP&E, usually straight line. The liability is amortized using the interest method. Depreciation and interest expense are recognized as currently with capital leases. Accrued interest is immediately booked to the liability account, rather than a separate accrued interest account.
 
Operating leases also create a right-of-use asset and liability, but the liability is called an “operating obligation,” not debt, meaning that it should not be counted as debt for loan covenants and financial ratios. Expenses are recognized in a single lease cost, which is normally straight-line over the lease’s life. For a simple operating lease with the same rent paid for its whole life and no asset adjustments, the net asset and liability are the same at all times. If there are scheduled rent increases, the leveling of rent is recognized as an adjustment to the asset, as are initial direct costs and lease incentives, all of which are amortized straight-line over the lease life.

Finance and operating lease assets and liabilities are reported separately (reflecting their different character; finance lease liabilities typically survive bankruptcy, for instance).
 
Two new disclosures are required: For finance and operating leases separately, the weighted-average remaining lease term (weighted by remaining liability), and the weighted-average discount rate (weighted by remaining lease payments, undiscounted).

Sale-leaseback

Sale-leaseback accounting is permitted only if the “sale” qualifies as a sale under the new Revenue Recognition standard (ASC 606/IFRS 15). This requirement precludes continuing lessee control of the leased asset other than the lease itself; most significantly, if the lessee has a purchase option at a fixed price (rather than fair value at time of exercise), sale-leaseback accounting is not permitted, and the transaction is treated as a financing.

Transition

Implementation is required for fiscal years starting after Dec. 15, 2018, including that year’s interim periods. Private companies may delay until fiscal years starting after Dec. 15, 2019, and need not implement for interim periods until the following year. When implemented, the prior two years must be restated using the new standard, to provide comparable information. Earlier implementation is permitted, but still requires the two-year restatement. (This does not mean refiling prior financial statements, but reporting the prior comparable periods as if the new standard had been in place as of the first comparable period.)

Several “practical expedients” are offered which most lessees are expected to use in transition. On that basis, lease classification is not reassessed; unamortized initial direct costs are carried forward and added to the lease asset without determining whether they qualify as IDC under the new rules. Balances on capital leases are converted to finance lease balances without adjustment (aside from combining accrued interest with liability, and IDC with the asset). Operating leases are set up with the liability equal to the present value of the remaining rents (using the incremental borrowing rate as of the transition date); the asset is the same, adjusted for any unamortized IDC, lease incentives, and deferred rent from leveling scheduled rent increases.

Note that for the two-year lookback period, you will need to retain the data to report leases both ways. In particular, it will be important to record both executory costs and non-lease components of the rent, so that each can be used for the appropriate reporting. 

Proposed changes that were eliminated

The 2010 Exposure Draft called for including all renewal options that were “more likely than not” to be exercised, and for projecting variable lease payments (such as those based on inflation or usage). Vehement disagreement on these proposals led the Boards to remove those proposals.

The 2013 Exposure Draft called for Type A and Type B lease classification based on characteristics of the lease (different rules for real property vs. equipment, in particular). The IASB decided to make all leases finance leases; the FASB decided to return to FAS 13’s classification system.
 
Lessors: The 2010 Exposure Draft called for creation of a Performance Obligation on leases previously considered operating, which would have affected lessor balance sheets. Lessor accounting for operating leases was reinstated virtually unchanged from FAS 13.

We will release later this year an update to our EZ13 lease accounting software which will fully comply with ASC 842. You can use EZ13 right now to forecast the impact of the new standard, because EZ13 includes the ability to treat operating leases as capital on a pro forma basis. For more information about how EZ13 can meet your lease accounting needs, whether you're a lessee or lessor, please check our web site or contact us.

Media coverage of new lease accounting standard

Several articles have been released discussing the FASB's new lease accounting standard:

New York Times: Post-Enron Accounting Rule Requires Companies to Report Leases

Wall Street Journal: New Rule to Shift Leases Onto Corporate Balance Sheets
Wall Street Journal (CFO blog): A Silver Lining to New Lease Accounting Rules: Savings

Accounting Today: FASB Releases Lease Accounting Standard

CFO: New FASB Lease Standard Could Inflate Balance Sheets
(CFO had a prior article on the complications facing companies that have to report under both US GAAP and IFRS: New Lease Standards May Demand Two Sets of Books)

Journal of Accountancy: New FASB leases standard brings transparency to lessee balance sheets

AccountingWeb: The Wait is Over: FASB Issues New Guidance on Lease Accounting

It's here!

Today (Feb. 25) the Financial Accounting Standards Board (FASB) released ASU 2016-02, the final version of the new lease accounting standard. In the Accounting Standards Codification, this is designated Topic 842 (the prior standard, FAS 13, was designated ASC 840). The release, available on the FASB web site, includes Section A, the main text, at 191 pages; Section B, a mind-numbing description of how the new text changes the existing Topic 840 text (148 pages); and Section C, background information and basis for conclusions (152 pages). This completes a process that started all the way back in July 2006 (and was originally expected to be completed in 2009).

Obviously, I can't look through 350 pages in a morning. There's no reason to expect any major surprises in the text. Illustrations are interspersed throughout the text. As a reminder, the new standard takes effect in 2019 (including interim periods in 2019); U.S. private companies get until year-end 2020 (interim periods don't have to use it until 2021).

To assist with understanding the new standard, the FASB released a Costs and Benefits summary, posted a 6-minute video entitled Why a New Leases Standard?, and announced a webinar for March 29, 1-2 PM EDT (1.0 CPE credit for CPAs).

The International Accounting Standards Board (IASB) released IFRS 16, their new lease accounting standard, on Jan. 12, 2016. Unlike the FASB, the IFRS text is not available for free; eventually the basic text will be released free (without the illustrative examples or basis for conclusions), but at the moment it's only available for purchase individually or as part of an eIFRS Professional Subscription.

I'll have more information in the coming days about the details of the new standard. We are working to complete the updates to EZ13 to meet the requirements of the new standard, including the transition from FAS 13. You can use EZ13 right now to forecast the impact of the new standard, because EZ13 includes the ability to treat operating leases as capital on a pro forma basis. For more information about how EZ13 can meet your lease accounting needs, whether you're a lessee or lessor, please check our web site or contact us.

Overview of the new standard

With the final decisions made, and just waiting for the official final document, what is the new regime for lease accounting? Most importantly, what is changing from the current standards?

US GAAP: FAS 13/ASC 840 to ASC 842

Lessee leasing: The most significant change, of course, is that all leases (except for those with a term of 12 months or less) must be put on the balance sheet. This was the primary reason for the whole project, and despite complaints from some quarters, there was never any real question that it would be implemented. However, the FASB chose to largely leave the distinction between capital and operating leases in place. (While for much of the deliberations the boards used the terms Type A and Type B, that nomenclature has fortunately been jettisoned; however, perhaps for convergence reasons, capital leases will now be called finance leases, while operating leases keep that name.)

One modest difference for classification is that the FASB added a capitalization criterion that was previously in IAS 17: whether the asset is so specialized that it cannot reasonably be repurposed. An example would be equipment installed at a remote mine which would be cost-prohibitive to move.

An operating lease is capitalized using the present value of the rents; the interest rate used is the implicit rate if known, otherwise the lessee’s incremental borrowing rate. (This is a change from FAS 13, which uses whichever rate is lower.) Since accurately knowing the implicit rate requires knowing the lessor’s unguaranteed residual, it’s most likely to apply only with leases that specify a purchase option. For simple leases, the asset and liability will be the same at any point during the life of the lease. If there are scheduled rent increases, the rent leveling effect will be reflected in the asset. Initial direct costs are added to the asset and amortized over the lease life.

While operating leases go on the balance sheet, the FASB specified that it should be treated as a “non-debt liability.” Thus, debt covenants should be unaffected by the change. It is nonetheless true, though, that certain financial ratios (current ratio, quick ratio, and return on assets) will be depressed by the addition of both assets and liabilities. (Terminology has changed from “obligation” to “liability.”) A second benefit to the separate accounting for operating leases is that expenses will generally be recognized straight line, rather than front-loaded as the depreciation + interest expense profile for a capital/finance lease works. This was a big deal to many lessees, virtually eliminating the impact of accounting on profit and loss calculations, equity, and tax vs. book timing differences.

Initial direct costs are no longer expensed as incurred. Instead, they are amortized straight-line over the lease life. However, this is limited to incremental costs, which effectively means only externally billed costs (commissions, legal fees, etc.), rather than rebilling internal costs.

Variable lease payments: Changes to rent due to future events (such as a change in an index or rate, or charges for excess use) remain contingent rents that are expensed as incurred. These can be positive or negative. If a lease must be recalculated due to other changes, though (such as a term extension or a revision to the base rent), the new variable lease payment level must be used for recalculation.

Lessor leasing: Almost unchanged, except that leveraged leasing (U.S. only) is being eliminated. Existing leveraged leases, however, will be grandfathered, including deals completed up to the implementation date.

Initial direct costs on sales type leases are recognized over the life of the lease unless the lease contains sales profit or loss.

IFRS: IAS 17

The IASB decided that all leases should be recognized using finance lease accounting. Thus, the present value of the rents must be capitalized; the liability is amortized using the interest method, while the right of use asset is depreciated, usually straight-line. This means that current operating leases will have a new front-loaded expense profile (because interest expense in a mortgage-style amortization is more at the beginning than at the end). However, short term leases (12 months or less) and low-value leases are considered out of scope. The IASB also scoped out “small ticket leases,” defined as having a value of $5,000 or less. (It’s interesting that a dollar amount is used for a standard that doesn’t apply in the U.S.)

The impact of front-loaded expenses will be the most significant for rapidly growing organizations; if the leasing portfolio is rolling over fairly consistently, the aggregate impact on P&L will be small, though individual cost centers may face significant impacts depending on where in the lease’s life they are. However, all entities will see an equity impact that grows fairly quickly after implementation until it potentially reaches equilibrium when leases start expiring at the end of a full term under the new regime. From the very beginning, though, most financial ratios will take potentially significant hits, due to adding equal amounts of assets and liabilities. (EBITDA is one exception; since expenses will now be reported as interest and depreciation, they will be absent from EBITDA.) Some companies will double their reported liabilities, which (even with a substantial equity balance) will make them look percentage-wise much closer to the margin. Many lessees with substantial portfolios will need to talk to their lenders about revising the debt covenants on loans.

Variable lease payments: If a lease has variable rents based on an index or rate (such as interest based on LIBOR), its liability must be recalculated whenever the rent changes. However, since the index rate is also usually used for the PV calculation, in most cases the liability won’t substantially change, though the expense reported as interest will increase.

Retirement obligations associated with leases are reported in accordance with IAS 37. The asset side of the provision (equivalent to what US GAAP, in FAS 143, calls an asset retirement obligation) is added to the right of use asset for the lease; subsequent changes to the provision result in adjustments to the ROU asset, which cannot be reduced below zero (if further adjustments are required because the liability is reduced, a gain is recorded).

Lessor leasing: Almost unchanged, except that determining the finance vs. operating classification will explicitly use the bright line tests of FAS 13: whether the lease term is 75% or more of the economic life, and whether the present value of the rents is 90% or more of the fair value of the underlying asset.

Shared by ASC 842 and IAS 17

The definition of a lease is “a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.” This includes a requirement of a specified asset; if the lessor can swap assets at will, for its own benefit (not counting the replacement of a non-functioning asset), the agreement is considered a service contract, not a lease.

All lease/rental agreements are out of scope (i.e., do not need to be reported according to the standard; you can simply expense the rent as paid, with no balance sheet impact nor footnote disclosure of future rents) if they are for a term of 12 months or less. In a change from the current standards, the definition of the lease term can include business practice as well as contractual obligations in determining whether options should be included, though the new standard of “reasonably certain” that the option will be exercised is considered functionally equivalent to the current “reasonably assured” term.

If the rent contains non-lease components, a lessee should allocate the rent to lease and non-lease expenses, using observable standalone prices for the services, if available, or estimating if necessary. ("Non-lease components" is a subset of "executory costs" in current accounting; passthrough costs such as taxes and insurance are now lease expenses and are capitalized with the base rent.)

Residual guarantees are capitalized at their expected, rather than maximum, value. Since this amount is usually zero, it will significantly reduce the likelihood that TRAC leases will be considered capital for US GAAP.

Sale/leaseback accounting has been tightened. The transaction must meet the requirements for a sale in FASB Topic 606 (IAS 15), the revenue recognition standard. If there is a fixed-price purchase option, sale/leaseback treatment is not permitted unless the lessee does not control the asset at the time of the transaction and is acting as an agent for the original owner. If the leaseback qualifies as a finance lease, then no sale/leaseback has occurred. A failed sale/leaseback remains on the lessee’s books as an asset with the leaseback accounted for as debt.

Subleases: The “head lease” (intermediary’s lessee lease) is accounted for separately from the sublease unless the transactions meet specific contract combinations guidance. Rent income and expense should not be offset, unless the intermediary serves as an agent under Revenue Recognition rules.

A modification of a lease is treated as a new lease if the lessee receives an additional right-of-use (i.e., additional assets), which is priced commensurately with a standalone price. Otherwise, a modification is treated as an adjustment to the existing lease, including an extension of the term. If the scope of the lease increases or stays the same, the current methodology of adjusting the asset and liability by the change in the present value of the rents still applies. If the scope of the lease decreases, a gain or loss is recognized in proportion to the decrease in scope. So if you have a lease covering ten trucks and you return one, you would recognize 1/10 of the current difference between asset and liability (if any) as a gain.

A lessor modifying a finance lease adjusts the discount rate to keep the net investment the same with the new terms.

Implementation: The new standard must be implemented effective January 2019 (the FASB styles it as “fiscal years starting after Dec. 15, 2018,” since some companies use fiscal calendars that start the same day of the week each year, which might be in the last week of December). Privately held companies have an additional year to comply. Earlier implementation is permitted, though the IASB requires implementation of the new revenue recognition standard, IFRS 15, no later than the same time.

The plan is for the final official documents to be released in January. Then the work of implementation begins. 

Obviously, there are more details, some of which are not yet explicitly stated. But there shouldn't be any significant surprises when the final document is released. More details are available on the FASB project page.

FCS is working on updating our EZ13 software to meet the new requirements. We will provide a fully compliant update for all current users with active support contracts, so you can implement the software now and be confident of a smooth path to upgrading. We've been at this for forty years, longer than almost anyone else offering lease accounting software, so you know that our solution will be thorough, well tested, and comprehensive.

(This post was updated 3/10/16 to correct the relationship of non-lease components and executory costs.)

FASB: New leases standard implementation in 2019

As I think most observers expected, the FASB at today's meeting set the implementation deadline as fiscal years starting after Dec. 15, 2018, i.e., calendar year 2019. This matches the IASB decision from last month. The FASB will permit early implementation; they seem to think it most likely that lessors will be early adopters. Given the potential impact on financial ratios, lessees are less likely to want to adopt early. Unlike the IASB, the FASB is not tying early adoption of the new leases standard (ASC Topic 842) to the recently adopted revenue recognition standard. Non-public entities will be given an extra year to comply (i.e., effective 2020).

One more substantive issue came up at the meeting. FAS 13 includes a provision that, if a leased asset is in the last 25% of its economic life, the lease is operating unless there is an ownership transfer or bargain purchase option. The new standard as written lacked any such bypass. Some constituents, particularly lessors, objected to this change, arguing that for lessors whose business model is based on repeated rentals of the same equipment, they could find the anomalous situation of a series of operating leases, followed by a capital lease near the end of the asset's life. Lessees would be potentially caught by the same situation. While there was some concern that this might not properly recognize lessors who are intentionally selling off old assets via lease, the proposed solution for the situation was to skip the economic life test if a lease starts near the end of the asset's life, but to leave the present value/fair value test in place.

With this complete, the deliberations are supposed to be finished. The FASB's news release for today's meeting says the final Accounting Standards Update should be published in early 2016.

Here at FCS, we are working on updating EZ13 to meet the new standard. The current version allows you to treat operating leases as capital, so you can anticipate the effect of putting operating leases on the balance sheet. Complete compliance with the new ASC 842 (and the update to IAS 17 for international entities) will be released next year. We are looking forward to assisting corporations and other reporting entities, both in the United States and throughout the world, in meeting the challenge of the biggest change to lease accounting in 40 years. FCS has been specialists in lease accounting since even before the initial release of FAS 13, and we are happy to put our accumulated expertise to work for customers ranging from Fortune 500 corporations to solo CPAs. Please contact us for more information about how we can help you.

IASB: New leases standard implementation in 2019

At the IASB's October 20 meeting, the board had its final deliberations on the new lease accounting standard. The headline decision is that the board decided that the new standard would be required starting with fiscal years beginning on or after January 1, 2019. Earlier implementation is permitted if an entity also implements IFRS 15, Revenue from Contracts with Customers, on or before the date the leases standard is implemented. While the FASB will make its decision independently, it is highly likely they will choose the same implementation date.

Other items discussed:

a. A lessee, and a lessor with a finance lease, will account for a lease modification that extends the life as a continuation of a lease, rather than a new lease agreement. This means that the impact of the modification is recognized immediately, rather than at the end of the existing lease. The FASB has made the same change.
b. If a lease's rent is based on a floating interest rate, the lease's discount rate should change whenever the rents are updated due to an interest rate change. (In other words, the discount rate for calculating the obligation will track the rate used to calculate the payments, which means that the obligation and asset won't change.)
c. End of lease restoration obligations should be accounted for in accordance with IAS 37, Provisions, Contingent Liabilities, and Contingent Assets. (This is virtually the same as FAS 143, Asset Retirement Obligations.) The asset side of the transaction is added to the right-of-use asset for the lease; subsequent changes in the provision obligation result in adjustments to the right-of-use asset as well.
d. Short-term (12 months or less) and low-value asset leases that are not capitalized can remain uncapitalized in a business combination. The FASB has made the same determination for short-term leases, but does not have a low-value asset exemption from lease accounting.
e. Any leases that are considered within scope of IFRS 5, Non-current Assets Held for Sale and Discontinued Operations, do not require additional disclosures beyond those specified in IFRS 5. (In other words, they are not included in regular lease reporting.)

The IASB says they are finished with all deliberations on leases, and will have a final ballot on the proposed standard before the end of the year.

IASB: It's a wrap

At the IASB's March 17, 2015, meeting, the board unanimously agreed that it is done with the new lease accounting standard, and committed their work to the drafting process. They considered whether or not another exposure draft was necessary, and concluded it was not, because all the substantive changes from the 2013 exposure draft either a) have been previously exposed (the single lease model was proposed in the 2010 exposure draft), b) are changes to retain existing accounting (lessor accounting), or c) are simplifications or clarifications responding to feedback received (such as excluding "small assets").

One IASB member stated an intention to dissent from the new standard. Presumably the others are on board.

The FASB is at essentially the same position. Neither board has stated a timeline more specific than "later in 2015" for when the final standard will be fully drafted and voted on. Neither have they set an effective date, though generally discussion has suggested two full years to prepare, which would suggest a January 1, 2018, effective date.

The IASB has released a summary document, Leases: Practical implications of the new Leases Standard, which describes the most important characteristics of the upcoming standard, with a comparison between current accounting and the two different standards that the IASB and FASB will be releasing.

It's been a slow train coming. The project was announced in July 2006. Maybe it'll be done for its ninth birthday, maybe not.

Standard release schedule update

The IASB has updated their project schedule with a target date for release of the new lease accounting standard: sometime in the second half of 2015. (The FASB's Current Technical Plan page has had a gee-whiz makeover that looks snazzy but provides no useful information about dates.)


At the December joint board meeting, the boards decided not to include in the definition of a lease that the lessee "must have the ability to derive the benefits from directing the use of an identified asset." So the definition remains “a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration,” with the requirement that the asset be implicitly or explicitly identified (rather than simply the use of one of an ever-changing pool of assets, which is considered a service contract rather than a lease).


No board deliberations on leases are scheduled for this month.

Misinformed congressmen in WSJ

In the Nov. 10, 2014, issue of the Wall Street Journal, congressmen Brad Sherman and Peter King attacked the planned new lease accounting standard, claiming that it will "fabricate trillions in new debt" and thereby crush the economy. They reference a study that foresees a loss of at least 190,000 U.S. jobs, and $27.5 billion in economic activity (up to a worst-case scenario of 3.3 million lost jobs and $400 billion in lost GDP!). All for an accounting change?

There are several problems with this attack. The most significant is that the study forecasts the effect of a standard that is no longer being proposed. The study was written in early 2012, when the proposal was to treat all leases as capital, including all optional renewal periods deemed "more likely than not" to be exercised. This proposal was eventually recognized as onerous by the boards, and substantially scaled back. While the IASB has retained the plan to treat all leases as capital with a one-size-fits-all calculation process, it eliminated including options unless exercise is "reasonably certain." The FASB has made the same adjustment to options, has chosen to keep a separate accounting model for operating leases, and is now saying that the liability to be shown on the balance sheet should be considered a "non-debt liability," meaning it will not affect debt covenants in loans, bonds, and the like.

The op-ed contains other inaccuracies. It suggests that under the new proposal, businesses would be burdened with "constantly tracking and remeasuring the 'fair value' of leases of every kind, from a business's office space to the photocopier down the hall." This is ridiculous, and was never part of any proposal coming from the boards. A fundamental concept of lease accounting is that fair value is not remeasured during the life of the lease, except by algorithm; the fair value is assumed to be the amortized net asset value, unless a material impairment needs to be recognized. This is true under FAS 13, and has not changed in the slightest as part of the new proposals. The op-ed also talks about accelerating expense recognition; that will happen to companies covered by international IFRS rules, but not under the current FASB proposal.

The op-ed notes that Congressman Sherman is an accountant. But obviously he doesn't have enough time to keep up on what's really happening in accounting. He should be embarrassed to have put his name on a column that misstates accounting principles and proposals so badly. (So should Rep. King, though he doesn't claim an accountant's credentials.) They darkly warn that Congress will have to act to rein in the FASB if the SEC doesn't. One hopes that they'll learn the actual facts before they try to politicize accounting standards.

The Nov. 17 issue of the Journal includes several letters to the editor, most of which point out the value of capitalizing lease obligations, and noting that banks often require doing this pro forma already. The new proposal, they argue, will simply reflect economic reality. I'm surprised that none of them note that Sherman and King are attacking a straw man.

Status of redeliberations: lessors

(See prior post for information on lessees and the general redeliberation process)

Lessor accounting update:

In response to a large chorus of, "It ain't broke, don't fix it," the boards in March decided that lessor accounting should be generally left unchanged.

How many models? Both boards agreed with a Type A/Type B separation, though changing the dividing line between them from the RED proposal back to the current FAS 13/IAS 17 of determining whether a lease is effectively an installment purchase that transfers the risks & benefits of ownership. Thus, substantially all current operating leases would become Type B leases; substantially all current capital leases would become Type A leases. However, the standard would be worded as a "principle" rather than a "rule", so the 90% and 75% tests would no longer be bright lines. The FASB further concluded, consistent with the forthcoming revenue recognition standard, that profit could only be recognized at commencement if control of the underlying asset is transferred (that is, there is an ownership transfer or bargain purchase option in the lease).

Finance accounting: The boards scrapped the "receivable and residual" methodology, and will leave the existing finance lease accounting in place (except that leveraged lease accounting seems still to be excluded).

Discount rate: Reference to property yield will be removed, and the rate the lessor charges the lessee is defined as the rate implicit in the lease, including initial direct costs. The discount rate is not to be reassessed even if a lease is modified.

Modifications: The April meeting dealt with issues not specifically addressed by the RED. As for lessees, if a lease is modified with the addition of new rights-of-use (such as additional square footage in a building, or additional equipment), and the increase in price is commensurate with that the cost would be to get the new assets on their own, the additional asset and rent should be recognized as a new lease. Otherwise, when a Type B lease is modified, the modified lease is in effect treated as a new lease (as is pretty much the case now), while a modification to a Type A lease is handled using IFRS 9 or FASB Topic 310. This is largely consistent with current IFRS practice; however, it represents a change for U.S. companies, which they think will be simpler to apply. In effect, when the criteria for derecognition of the asset are met, the modified lease is treated as a new lease; otherwise, the carrying value is recalculated using the original discount rate, with the offset recognized in profit or loss.

Variable lease payments: The RED called for recalculating variable lease payments (VLPs) based on an index or rate, and the lease as a whole, when the rate changes. At the April meeting, the boards decided that lessors would not be required to reassess VLPs at all. Instead, any differences between the original estimate and actual payment are recognized in profit and loss as incurred, the same as FAS 13/IAS 17 call for now.

Short term leases: See lessee update.
Purchase & renewal options: See lessee update.
Timeline: See lessee update.

Status of redeliberations: lessees

The FASB and IASB are underway with their redeliberations on the lease accounting standard, in the wake of the 641 letters received, plus additional outreach the staff and boards have undertaken since releasing the 2013 Exposure Draft. The deliberations are taking somewhat different turns for lessees and lessors, so I'm going to put up two separate posts to deal with them.

Lessee accounting:

This is by far the more contentious side of the discussions. Fundamentally, the problem is that different leases are viewed by lessees and investors in different ways. Lessees of real estate and of relatively short-term equipment leases don't see their leases as acquisitions, but as usage contracts. They are pushing back strongly against the idea of front-loaded expenses, as is inherent in finance lease accounting (where the expenses are interest and straight-line depreciation, as is typical with current capital leases). Many of them also are objecting to putting the value on the balance sheet at all, even though that is the primary reason for the entire rewrite of the lease accounting standard.

Some investors and lenders agree with these lessees. Others want all leases fully hitting the financial statements, just as current capital leases do. Others want to be able to do their own massaging of the numbers.

The first exposure draft in 2010 strongly supported the "capitalize everything" mantra. It was buried under criticism. The 2013 revised exposure draft (RED) sought to mollify those of the "usage" persuasion by allowing a straight-line expense recognition for real estate and certain short-term equipment leases, which it calls "Type B" leases. But it faces fire from both sides: it doesn't permit as many leases to be Type B as are currently operating, which upsets lessees, but by having two accounting methods, it presents opportunities for similar leases to be treated differently (one of the complaints with FAS 13/IAS 17), and the depreciation methodology for the asset is a plugged number, which offends many accounting purists and raises issues for how to deal with impairments. Others complain that assets and liabilities are recognized which have no standing in bankruptcy (leases can be rejected wholesale).

With all that as preamble, let's look at what's happened in the last few months since the boards started substantive redeliberations:

How many models? We have a split between the boards on this fundamental issue. The FASB wants to keep the Type A/Type B separation, though changing the dividing line between them to the current FAS 13/IAS 17 of determining whether a lease is effectively an installment purchase that transfers the risks & benefits of ownership. Thus, substantially all current operating leases would become Type B leases; substantially all current capital leases would become Type A leases. However, the standard would be worded as a "principle" rather than a "rule", so the 90% and 75% tests would no longer be bright lines. On the other hand, the IASB prefers to treat all leases as Type A. It remains to be seen whether convergence will be possible, or if the different constituency pressures of the two boards will result in an unconverged standard.

Modifications: The April meeting dealt with issues not specifically addressed by the RED. If a lease is modified with the addition of new rights-of-use (such as additional square footage in a building, or additional equipment), and the increase in price is commensurate with that the cost would be to get the new assets on their own, the additional asset and rent should be recognized as a new lease. Otherwise, the lease is recalculated, including a new discount rate, as of the date of modification. If the liability increases, the asset increases by the same amount. If the liability decreases, a proportional amount of asset should be removed (remember that the asset and liability aren't the same for a Type A lease during the lease life), and a gain or loss recognized for the difference between the asset and liability removed.

Variable lease payments: The RED called for recalculating variable lease payments (VLPs) based on an index or rate, and the lease as a whole, when the rate changes. At the April meeting, the FASB decided for lessees to reassess VLPs only when the lessee remeasures the lease liability for other reasons (for instance, because the lease term is changing). The IASB voted to reassess for that reason or if the cash flows change due to a change in the reference index or rate. There is no change to the exclusion of VLPs that are based on other factors, such as usage, nor to the reqirement to include VLPs that are in-substance fixed (that is, payments that are written as if they are variable merely to game the system). This leaves a substantial difference between the boards; the FASB's exclusion of remeasurement for changes in rates matches what is done currently under FAS 13, and considerably simplifies compliance. It has not been discussed whether future rent commitments would need to be adjusted for changes in rates, or would also stay fixed at the initial values.

Discount rate: The boards decided to tighten the definition of the "rate the lessor charges the lessee" to be specifically the implicit interest rate, not the yield, to avoid lessees being able to choose from multiple rates.

Short term leases: The exemption for leases of 12 months or less is maintained. The boards now define the 12 months the way the lease term is defined, excluding arms-length options, so a 12-month lease with a renewal option (without an economic incentive to renew) can now be treated as short-term, contrary to the RED proposal.

Purchase & renewal options: A lessee should reassess whether exercise of an option is "reasonably certain" (and thus must be recognized) only upon the occurrence of a significant event or a significant change in circumstances that are within the control of the lessee.  The boards explicitly agreed that the term "reasonably certain" is a high hurdle, meant to be essentially the same as the current "reasonably assured." (Why they didn't want to keep the current terminology is unclear.) The original exposure draft's contemplation of reassessing every year or every reporting period has been definitively eliminated.

Contract combinations: If two or more leases are entered into at or about the same time between the same lessee and lessor, and either they were negotiated as a package, or the amount paid for one contract depends on the price or performance of the other (such as a volume discount), then they should be considered a single transaction.

Timeline: The Current Technical Plan on the FASB web site shows no expected date for completion in 2014. (Revenue Recognition, no the other hand, is expected to be finalized this quarter.) However, observers such as Bill Bosco of Leasing 101 think the boards are pushing hard to finish in 2014, with no new exposure draft.

The boards meet again this week to discuss:
• Definition of a lease
• Separating lease and nonlease components
• Initial direct costs and lease incentives
Discussion papers are available at the IASB web site.

Revised Exposure Draft released

At long last, the Revised Exposure Draft (RED) for the proposed new lease accounting standard has been released by the IASB and FASB. A press release is available here; the actual RED is available from either the IASB or FASB.

The public comment period lasts until Sep. 13, 2013. Comments may be submitted here or by email to director@fasb.org; email submissions should include File Reference No. 2013-270. (You can also submit comments via the IASB web site if you're a registered user; it all goes into a single compilation.) There are 12 specific questions that the boards are asking for responses to. The FASB online response form is structured with boxes to respond to each question (plus a box for any other issues that someone may want to comment on).

The boards will have public webcasts to discuss the RED on May 20. The IASB will hold one at 8:30 BST (British Summer Time, GMT +1); registration is available here. A joint FASB/IASB webcast will be held at a more reasonable hour for Americans, 10:30 AM EDT; registration is available here.

One interesting thing that jumps out is that FASB has assigned a new topic number in the Accounting Standards Classification. Leases currently is Topic 840. The new proposed standard is Topic 842. The use of a new number may reflect the fact that the two of them will be active simultaneously. There's no indication from the IASB whether they will keep IAS 17 as the standard number for Leases.While the boards say that the texts are almost identical, with the differences "primarily related to existing differences between U.S. GAAP and IFRS and decisions the FASB made related to nonpublic entities" (quoting from the press release), they're formatted quite differently, as the FASB has structured the RED to fit the format of the ASC, with four multidigit numbers separated by dashes defining the hierarchical structure (it starts at 842-10-05-1), and various changes to related current standards are shown with strikeouts of existing text and underlined new text. Frankly, the IASB version is far easier to read; I haven't liked the ASC ever since it came out, because the structure makes everything so choppy (especially if you don't have a paid subscription to the online ASC).

Another item that immediately jumps out is that the boards haven't been able to come up with a good name for the different types of leases: A "Type A" lease uses the current capital/finance lease accounting methodology, while a "Type B" lease uses the straight-line expense methodology. Couldn't they use slightly more descriptive titles? I suppose over time we'll get accustomed to them, but do we really need more monikers that have no inherent meaning? Some people have been referring to the two types as I&A (interest and amortization) and SLE (single lease expense), which focuses on the most noticeable difference between the two types; I think something like that would be far less confusing.

While the pieces of the proposal have been discussed here in numerous prior posts, we'll take some time in coming weeks to look at the RED systematically.

Let the comments begin!

The pendulum swings again

The big news last month was that the FASB & IASB decided to reinstate a close cousin of operating lease accounting for lessees, with a level expense recognition pattern (though the leases would still be reported on the balance sheet). It was a sharply divided vote. Now, a few members of each board have switched sides, and in another divided vote, the boards have decided to ditch the "other-than-finance" lease category and account for all lessee leases the same way, as finance leases. This means a forward-leaning expense profile (depreciation is equal over the life of the lease, but interest is higher at the beginning of the lease, just like with a mortgage), which many respondents to the Exposure Draft vehemently protested. One reason given was that board members didn't like the options for how to account for the level expense recognition.

The boards also informally voted to eliminate the exemption of short-term leases (12 months or less maximum lease term, including renewal options) from the requirements of the standard that was agreed to in March. However, that will be reviewed and finalized at a later meeting.


Options

In another backtrack that most lessees won't like, the boards have increased the likelihood that options will need to be included in the lease term. In deciding whether to include an option, one must decide if there is a "significant economic incentive" to renew. A prior meeting decided that only economic factors should be considered in this determination (including contract-based factors such as below-market rents or penalties for non-renewal, and asset-based factors such as the existence of large leasehold improvements that would normally be amortized over a longer period). The boards have now decided to include "entity-specific factors," such as historical practice of the company or industry and management intention. The boards noted that a single factor does not have to be determinative, but the door is still opened up to an increase in subjectivity and need for ongoing review.

Lessor accounting

The boards haven't decided if lessors will use one or two approaches to accounting for their leases. So they made decisions for either possibility:

One approach

If all leases are treated the same way, the partial derecognition model will be used, with the residual value accreted over the life of the lease. This is, I believe, basically the same as current finance lease accounting (sales type accounting under FAS 13).

Two approaches

If two methods of accounting are used, leases will be distinguished based on whether the lease transfers substantially all of the risks and rewards incidental to ownership of the underlying asset. This is the concept underlying both FAS 13 and IAS 17. The boards clarified that among the indicators would be comparing rent to fair value and the existence of variable rent (the latter would be an indication that risks have been transferred to the lessee). Existence of embedded or integral services would not be considered in the determination.

For leases that transfer substantially all of the risks and rewards of ownership, the entire asset would be derecognized, with the residual initially measured at its present value and accreted over the life of the lease.

For other leases, the boards could not come to an agreement. The IASB preferred derecognition, while the FASB preferred current operating lease accounting. This will be revisited at a future meeting. (Neither board, though, preferred the Performance Obligation (PO) method that was presented in the Exposure Draft. That seems to be dead.)

Lease modifications

The boards decided that a "substantive change" in a lease agreement would result in treating the modified agreement as a new contract. This applies if the new terms would change the determination of whether the contract is or contains a lease, or the determination of whether substantially all the risks & rewards of ownership are transferred to the lessee. A change in circumstances (not of the contract itself) can cause reassessment of whether the contract is or contains a lease, but not whether risks & rewards of ownership are transferred.

Discount rate

The interest rate used to present value the rents and amortize the principal (obligation or receivable, depending on whether it's the lessee or lessor) will not be reassessed if the lease payments don't change. However, if a lease is extended because an option needs to be included (either because an option is exercised, or it is deemed to be includible because of a newly recognized "significant economic incentive"), the discount rate (which is typically the incremental borrowing rate for lessees) is to be reassessed, using the current rate, and the present value of the remaining rents is then recalculated.

More decisions, summarization so far

The FASB and IASB met again last week to further deliberate on leases. Among the decisions reached:

Start of accounting: A lease may be signed well in advance of when the lessee takes possession of the property (particularly with property, which may need extensive construction before occupancy). The boards have affirmed that the lease does not hit the books until the "commencement" of the lease, which is normally when possession is granted. Payments made between the "inception" (signing) and "commencement" will be accounted for as prepayments (an asset that is then folded into the ROU asset at commencement). If the lease meets the definition of an "onerous contract," it is to be accounted for during the inception to commencement period according to the Contingencies accounting standards: IAS 37 and FASB Topic 450.

Tenant incentives: Lessees are to subtract these from the right-of-use asset.

Sale & leaseback: Rather than a series of tests in the Exposure Draft to determine whether a transaction qualifies for sale and leaseback accounting, the boards have now decided that as long as the sale part of the transaction meets the existing accounting requirements (under the Revenue Recognition standard) to recognize a sale, it qualifies for SLB treatment. In general, if control of the asset has passed to the buyer/lessor, it qualifies. One change from current SLB accounting is that if the seller/lessee has a gain or loss on sale, that is to be recognized immediately, rather than amortized over the life of the lease.

Leases with service components: When the service component is not clearly identified separately in the agreement, the FASB in the ED called for capitalizing the entire contract as a lease (the IASB favored split recognition). Both boards have now decided that if the purchase price of one component (lease or service) is "observable," you can calculate the split based on that.

Discount rate: FAS 13 calls for the interest rate on lessee capital leases to be based on the lease's implicit interest rate, if known, or the lessee's incremental borrowing rate (IBR). In many cases, the lessee doesn't know the lessor's implicit rate, because the expected value of the asset at lease expiration (the "unguaranteed residual") is not stated, so the IBR tends to be used. (The rate may be higher if the present value of the rents using these rates is more than the fair market value; in that case, a rate is calculated to make the PV of the rents equal to the FMV.)

The ED introduced a new term: "the rate the lessor charges the lessee." This is to be used when available, a decision now confirmed. Finally, though, the boards have defined what they meant; this can be (from the observer summary) "the lessee's incremental borrowing rate, the rate implicit in the lease, or, for property leases, the yield on the property. When more than one indicator of the rate that the lessor charges the lessee is available, the rate implicit in the lease should be used." The lessor always by definition knows this rate. If the lessee does not, the IBR is to be used.

Initial direct costs: The boards defined this as "Costs that are directly attributable to negotiating and arranging a lease that would not have been incurred had the lease transaction not been made." The intent is to have a consistent definition for a series of standards (including insurance and revenue recognition, which are at similar stages of development), though there may be slight modifications to meet specific needs of the different standards. Any such differences are intended to be explained by the boards, to maintain the overall consistency.

IDCs are to be capitalized by both lessees and lessors, by adding them to the right-of-use asset and right to receive lease payments, respectively.

Summarization: The IASB staff has prepared a detailed description of the impact on the ED of the new decisions by the boards. This describes both the confirmed decisions and the changes, with links to IASB observer notes for each.

Thanks to the IASB for their podcast and to Asset Finance International for their summary.

Ownership transfer leases, update

In my March 17 post, I said that it wasn't clear how the scope change affected leases with an ownership transfer. Based on the IASB Update just released regarding last week's meeting, it seems clear that they are also to be considered leases. The boards have decided to simply eliminate the language that took leases with bargain purchase options and ownership transfers out of scope of the leasing standard.

Purchase options and short-term leases

The FASB & IASB met this week for continuing discussions, on leases as well as other topics. In their meetings on March 14 & 15, they reached the following conclusions for the new lease accounting standard:

• The ED had scoped out (excluded) leases with bargain purchase options and ownership transfers (also called "in-substance purchases") from the new lease accounting standard, stating that they should be treated as a sale & purchase and handled according to the revenue recognition standard (which is also at the ED stage). However, this decision was left over from when the boards had briefly planned to treat all lessor leases according to the "performance obligation" model, which would have been inappropriate for these transactions. With a derecognition model for lessors now in place, the need to separate out these types of leases is less evident. The boards agreed that leases with a bargain purchase option should be returned to the scope of the leases standard. It's not yet clear if leases with ownership transfer will be considered leases or sales.
• Relatedly, the boards are adjusting the treatment of purchase options. In the ED, these did not need to be accounted for until exercised. Now, they must be accounted for if there is a "significant economic incentive" to exercise them. It remains to be determined how the accounting will work if the conclusion of a significant economic incentive changes in the middle of the life of the lease (in either direction), though the boards concluded that they would not permit a switch between the "finance" and "other than finance" categories they set up last month.
• Short-term leases: The boards have decided that leases with a maximum lease term of 12 months or less, including renewal options, can be treated like current operating leases. They will not be shown on the balance sheet for lessees; income and expense will be shown on the income statement as currently (with rent leveling as needed). This will be an option; lessees & lessors can choose to treat short-term leases like other leases. However, the option must be chosen for all leases in an asset class, rather than lease by lease.

Thanks to Deloitte's IAS Plus and Asset Finance International for their reviews of the meetings, which were the basis for this entry.

2015 implementation?

The new leasing standard is one of several major standard revision projects the FASB & IASB have underway. Others include revenue recognition and insurance contracts, which are considered heavily interrelated with the leases, and other comprehensive income, fair value measurements, financial instruments with characteristics of equity, and financial statement presentation, which are considered more independent of other standards.

The boards put out a separate Exposure Draft asking for comments on implementation dates. While the volume of comments wasn't nearly as high as for the leases ED, the consensus response was that the impending changes are major, and financial statement preparers need substantial time to update their systems. At the boards' combined March 2 meeting, the boards didn't decide whether to implement the three linked standards (leases, revenue recognition, and insurance contracts) at the same time or in staggered order, but stated that they "will provide adequate time for stakeholders to apply the new requirements." Several members of the IASB stated a preference for 1/1/2015 as the implementation date, while most FASB members didn't want to make a commitment to a date at this time, and several expressed a preference for a staggered implementation.

Note that since U.S. companies typically report two years of comparables, and the leases ED says those comparable years will need to be restated on implementation, that means that effectively companies would need to apply the standard effective 1/1/2013, even though they wouldn't be reporting the results accordingly until later. It's not clear yet whether earlier implementation will be encouraged or permitted.

They hear you

Anyone who had any doubts that the FASB and IASB seriously consider responses received during their "due process" steps need only look to last week's meetings and the decisions reached on lease accounting. In addition to the previously reported complete reversal on the lease term, the boards have made an almost complete reversal on contingent rents, and are planning to substantially alter the standard to respond to the desires of those who want level recognition of expenses over the life of a lease. These three topics were probably the most strenuously argued in comment letters to the Exposure Draft.

The boards aren't backing down on putting lessee leases on the balance sheet. But they're showing that they are willing to work with preparers and accountants to make the standard more workable and less onerous.

Contingent rents

The Exposure Draft called for all contingent rents to be included in the capitalized lease payments using a probability-weighted estimate, based on a "reasonable number" of estimates. Rents based on an index or rate were to use forward rates when "readily available." Estimates would need to be revised as often as once a quarter, with changes in future rents booked as upward or downward adjustments to both the asset and the obligation (changes affecting current or prior periods would be immediately expensed).

Preparers howled. The work involved would be enormous, and would often involve forecasting well beyond normal planning horizons (a 20-year lease with a percent of sales kicker would require forecasting sales out that far, when few companies go past 5 years in their regular forecasting). The requirement for quarterly reassessment, even if softened by stating there needs to be a "significant change," would add measurably to the load of releasing statements. Much of this could not be automated, because contingent rents have immense variability in terms.

The boards have now almost completely reversed themselves. The new plan agreed to last week is that contingent rents need to be included in the capitalized rent stream in just the following cases:

* they are based on an index or rate--and in that case, the current rate is used, with no use of forward rates, though it will need to be updated each reporting period (unlike current GAAP, where the rate at lease inception is used throughout the life of the lease)

* they are "reasonably assured," with the definition to be determined later

* the base rent is below market rates

Other contingent rents will be subject to disclosure, but not capitalization.

Expense recognition pattern & placement

Many respondents to the ED complained about the income statement effect of capitalizing all leases. They didn't like two different aspects of this:

* Amortizing the obligation using the interest method, while amortizing the asset on a straight-line basis, means that expenses are greater in the early months & years of a lease, then decline over time.

* Lease payments and interest expense would classified as financing activities. Both interest and depreciation expense are excluded from EBITDA (earnings before interest, taxes, depreciation, and amortization), which is an important measure of earnings for many companies.

Those who objected felt that level expense recognition was more reflective of economic reality, and that leasing should be considered operational rather than financing activity.

The boards concluded that there are two types of leases. Some leases truly are financing transactions (such as most current capital/finance leases). For those, the boards believe the current plan of interest and depreciation is appropriate. But others, they conclude, do not have a strong financing component, and a level expense pattern would be more appropriate.

Can you say "classification"? One of the big reasons for the new lease accounting standard was supposed to be eliminating classification of leases into two types, because of the concern that similar leases are being accounted for differently (those just on either side of the dividing line). The stories about leases with a present value of 89.9% of the fair value (just below the 90% line that makes a lease capital) have been around for a long time. Just because the bright lines are going away doesn't mean that there won't be structuring.

But the boards seem to be accepting that different reasons for leasing merit different accounting treatment. They may also be swayed by the fact that different ways of recognizing expenses can have collateral impact--companies that depend on expense reimbursement from government medical and other contracts, for instance, noted that rent expense is often reimbursable, while depreciation and interest on debt are not. They may also be concluding that the effect of possible structuring in these cases isn't as egregious as making things disappear entirely from the balance sheet.

Of course, once you say that there are two types of leases, the question becomes, how do you tell which is which? The new standard is supposed to be "principles based" rather than "rule based," so we won't have a 90% or 75% test. Instead, the boards are looking to prepare a list of factors which would be considered. Some of them are (a) residual asset, (b) potential ownership transfer, (c) length of lease term, (d) rent characteristics, (e) underlying asset, (f) embedded or integral services and (g) variable rent (thanks to Deloitte for its notes on the meeting that had this list). The boards will be discussing in the future how these factors interact, as well as proper presentation of leases considered "other than financing."

Lease vs. Service Contract

The boards spent considerable time continuing to try to differentiate between leases and service contracts (when a contract has elements of both). One conclusion they reached is that if an asset is incidental to a service, it doesn't have to be accounted for separately. (So, for instance, when you get a cable TV subscription that includes a cable box, the box doesn't have to be treated as a lease.) They also tentatively decided that the requirement for a specified asset is still met if the lessor has the right to swap out an equivalent item assuming no disruption of service (such as replacing a copier with another of the same model).

Most discussion was focused on lessee accounting. The boards have decided to discuss that primarily at this point, with the intention to get back to lessor accounting to keep things as symmetrical as possible.

A number of the decisions and issues will be reviewed with preparers, users, and accountants, with a report back to the boards at a later date.