(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.
Showing posts with label Lessors. Show all posts
Showing posts with label Lessors. Show all posts
Monday, May 19, 2014
Tuesday, July 26, 2011
Second Exposure Draft coming
I need to catch up on the boards' activity over the last two months. I've taken a summer hiatus, but they didn't...
The most important news is that at the July 21 meeting, the boards unanimously decided to release a second Exposure Draft. The changes to the proposed standard from the original Exposure Draft are so significant that they felt it important to get feedback from interested parties. Some decisions remain to be made before the new Draft can be released; they expect to complete those deliberations during Q3, with a new Draft released soon after. The wording seems to suggest that the Draft would come out in early October.
Additional decisions reached this month:
Lessor Accounting
The performance obligation model has been scrapped. All leases (except for short-term leases) will be accounted for using a "receivable and residual" model, which is essentially the same as the "derecognition approach" described in the Exposure Draft. Main points of this model:
* The lessor recognizes a right to receive lease payments (matching the lessee's obligation to make payments) and a residual asset.
* The discount rate to present value the payments is the "rate the lessor charges the lessee" (the internal rate of return, based on the asset's value).
* The residual asset accretes (increases using the interest method, same interest rate) over the lease's life.
* If the asset's carrying amount is lower than the lease's value, a profit (on the portion of the asset represented by the lease receivable) can be recognized at commencement of the lease if reasonably assured.
Short-term leases, defined as those with a maximum term of 12 months or less, will be accounted for as operating leases (no balance sheet effect, just income recognized over the lease term on a systematic basis, usually level). This will protect against needing to do convoluted accounting for things like rental cars and hotel rooms.
Operating lease accounting will also be permitted for leases of investment property measured at fair value. This is currently only available under IFRS (IAS 40). But the FASB is working on a proposed investment property standard which would be similar, with an Exposure Draft scheduled for Q3 2011.
Contingent Rents Dependent on an Index or Rate
While other contingent rents are excluded from the capitalized calculation of leases, those that depend on an index or rate have to be included. An example would be a lease whose rent is based on CPI or LIBOR. Such leases are to be initially measured based on the index/rate at the commencement of the lease, then recalculated at the end of each reporting period using the new index/rate. The change is booked to net income if it applies to the current reporting period, or as an adjustment to the right-to-use asset (for a lessee) for adjustments that relate to future periods. Lessors would recognize an adjustment in the receivable in profit or loss.
This is a potentially significant cause of recalculations on leases; many real estate leases have CPI escalators that adjust every year. The boards decided that the benefit of more accurate presentation of actual rents due outweighs the effort required.
Lessee disclosures
The boards approved a lengthy set of disclosures for lessees:
* Reconciliation of opening & closing balance of right-to-use assets, disaggregated by class of underlying asset
* Reconciliation of opening & closing balance of lease liabilities (no disaggregation required)
* Future rent commitments, similarly to current FAS 13 requirements (by year for five years, then all remaining, then subtracting interest to reconcile to the liability balance). Note that this is different from current IFRS requirements. Preparers would have the option to disclose by year for more than 5 years, if that would provide better information.
* Information about leases signed but not yet started if they create "significant" rights and obligations
* Information about contingent rentals and options
* A table of expenses: amortization, interest, variable payments, and short-term rents, plus a breakdown of principal and interest paid
* Information regarding any expected material changes in short-term rentals
However, they explicitly are not requiring disclosure of discount rates, fair value of liabilities, purchase options, or initial direct costs.
They also explicitly forbid combining interest and amortization expenses and presenting the total as lease or rent expense.
The boards split over whether or not to disclose future commitments for services and other non-lease components; the FASB wants such disclosure (which is already required by the SEC in the unaudited portion of the financial statements), while IASB does not. Presumably this will be reconciled at a later date (perhaps after the Exposure Draft is released and reviewed).
Lessee primary financial statements presentation
Lease right-of-use asssets and liabilities either must be presented separately in the Statement of Financial Position (balance sheet), or shown separately in footnote disclosures. The right-of-use asset is to be presented according to the type of underlying asset (land leases with land owned assets, etc.). They have decided not to define whether the right-of-use asset is tangible or intangible. This is a question that affects some regulated industries for tax and other purposes. The boards have decided to let the relevant regulatory bodies make the determination appropriate to their purposes.
The Statement of Cash Flows would show principal and interest payments in accordance with requirements for other financing. Variable lease payments (not capitalized) and short-term rentals are operating cash flows. New leases (creating a new asset & liability) would be an additional non-cash disclosure.
June meeting results in next post...
The most important news is that at the July 21 meeting, the boards unanimously decided to release a second Exposure Draft. The changes to the proposed standard from the original Exposure Draft are so significant that they felt it important to get feedback from interested parties. Some decisions remain to be made before the new Draft can be released; they expect to complete those deliberations during Q3, with a new Draft released soon after. The wording seems to suggest that the Draft would come out in early October.
Additional decisions reached this month:
Lessor Accounting
The performance obligation model has been scrapped. All leases (except for short-term leases) will be accounted for using a "receivable and residual" model, which is essentially the same as the "derecognition approach" described in the Exposure Draft. Main points of this model:
* The lessor recognizes a right to receive lease payments (matching the lessee's obligation to make payments) and a residual asset.
* The discount rate to present value the payments is the "rate the lessor charges the lessee" (the internal rate of return, based on the asset's value).
* The residual asset accretes (increases using the interest method, same interest rate) over the lease's life.
* If the asset's carrying amount is lower than the lease's value, a profit (on the portion of the asset represented by the lease receivable) can be recognized at commencement of the lease if reasonably assured.
Short-term leases, defined as those with a maximum term of 12 months or less, will be accounted for as operating leases (no balance sheet effect, just income recognized over the lease term on a systematic basis, usually level). This will protect against needing to do convoluted accounting for things like rental cars and hotel rooms.
Operating lease accounting will also be permitted for leases of investment property measured at fair value. This is currently only available under IFRS (IAS 40). But the FASB is working on a proposed investment property standard which would be similar, with an Exposure Draft scheduled for Q3 2011.
Contingent Rents Dependent on an Index or Rate
While other contingent rents are excluded from the capitalized calculation of leases, those that depend on an index or rate have to be included. An example would be a lease whose rent is based on CPI or LIBOR. Such leases are to be initially measured based on the index/rate at the commencement of the lease, then recalculated at the end of each reporting period using the new index/rate. The change is booked to net income if it applies to the current reporting period, or as an adjustment to the right-to-use asset (for a lessee) for adjustments that relate to future periods. Lessors would recognize an adjustment in the receivable in profit or loss.
This is a potentially significant cause of recalculations on leases; many real estate leases have CPI escalators that adjust every year. The boards decided that the benefit of more accurate presentation of actual rents due outweighs the effort required.
Lessee disclosures
The boards approved a lengthy set of disclosures for lessees:
* Reconciliation of opening & closing balance of right-to-use assets, disaggregated by class of underlying asset
* Reconciliation of opening & closing balance of lease liabilities (no disaggregation required)
* Future rent commitments, similarly to current FAS 13 requirements (by year for five years, then all remaining, then subtracting interest to reconcile to the liability balance). Note that this is different from current IFRS requirements. Preparers would have the option to disclose by year for more than 5 years, if that would provide better information.
* Information about leases signed but not yet started if they create "significant" rights and obligations
* Information about contingent rentals and options
* A table of expenses: amortization, interest, variable payments, and short-term rents, plus a breakdown of principal and interest paid
* Information regarding any expected material changes in short-term rentals
However, they explicitly are not requiring disclosure of discount rates, fair value of liabilities, purchase options, or initial direct costs.
They also explicitly forbid combining interest and amortization expenses and presenting the total as lease or rent expense.
The boards split over whether or not to disclose future commitments for services and other non-lease components; the FASB wants such disclosure (which is already required by the SEC in the unaudited portion of the financial statements), while IASB does not. Presumably this will be reconciled at a later date (perhaps after the Exposure Draft is released and reviewed).
Lessee primary financial statements presentation
Lease right-of-use asssets and liabilities either must be presented separately in the Statement of Financial Position (balance sheet), or shown separately in footnote disclosures. The right-of-use asset is to be presented according to the type of underlying asset (land leases with land owned assets, etc.). They have decided not to define whether the right-of-use asset is tangible or intangible. This is a question that affects some regulated industries for tax and other purposes. The boards have decided to let the relevant regulatory bodies make the determination appropriate to their purposes.
The Statement of Cash Flows would show principal and interest payments in accordance with requirements for other financing. Variable lease payments (not capitalized) and short-term rentals are operating cash flows. New leases (creating a new asset & liability) would be an additional non-cash disclosure.
June meeting results in next post...
Wednesday, May 25, 2011
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.
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.
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
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.
Friday, May 21, 2010
Performance obligation or derecognition—or both?
The FASB & IASB, at meetings May 18 & 19, revisited one of the fundamental decisions on lessor accounting made last year. As the staff’s agenda paper put it then, “What is the credit?” Setting up a capital lessor lease means setting up a receivable for the rent income stream. That’s a debit on the balance sheet. How should the balancing credit be characterized?
The boards considered two basic approaches. The first, which is the current methodology under FAS 13 and IAS 17, is derecognition: the owned asset is credited (reduced/eliminated). Under present accounting, the entire asset is derecognized, replaced by the receivable. Things get more complicated in the proposed new system, since many leases will be for only part of the value of the underlying asset. Crediting the asset would leave part of the owned asset on the books. More problematic is that multiple leases of a single asset could result in a sum total of receivables that is greater than the original asset value; how is that to be handled?
The solution the boards came up with was to create the concept of a performance obligation, representing the requirement to make the asset available to the lessee. This is a credit entry that is amortized over the life of the lease, based on passage of time or usage of the asset.
There have been rumblings for several months that several members of the boards are uncomfortable with the performance obligation methodology. Recent notes on lessor accounting have included explicit comment that decisions are “under the performance obligation approach.” At this week’s meetings, there was extensive discussion of going back to a derecognition approach, though this would be a “partial derecognition” approach. Described in detail in the agenda papers for the meetings, this means that the owned asset wouldn’t be completely taken off the books (unless the lease is for the entire useful life of the asset). A portion of the asset would be removed and replaced with the receivable.
The boards made decisions on how to account for various aspects of lessor activity under a partial derecognition approach, without committing to such an approach. You can read the full list of decisions in the FASB Action Alert. I’m not going to repeat all of it because it’s not clear if it will actually take effect, and I’d just be restating what they state there.
One significant implication of a partial derecognition approach is that a lessor could recognize a profit at the beginning of the lease (as is currently done with sales-type capital lessor accounting). The boards' prior decisions on lessor accounting with a performance obligation did not permit an up-front recognition of profit; instead, all income is to be recognized in the form of interest over the life of the lease. This has potentially a major impact on the reported profitability of manufacturers who lease their equipment. One can expect that they will lobby hard for a derecognition approach.
Conceptually, a derecognition approach seems to the staff to be more consistent with the lessee right-of-use approach. However, the unguaranteed residual value becomes much more significant in this approach, which can increase complexity.
The boards haven’t concluded which way to go, and significantly, there’s a difference of opinions between the boards. The FASB prefers to stick with the performance obligation methodology; the IASB prefers a hybrid model, using a performance obligation in some cases and derecognition in others. (The FASB Action Alert summary doesn't list the vote, but based on prior activity, I doubt it was unanimous with either board.) They’ve asked their staff to develop proposals to decide when to apply which model. But won’t that inevitably result in structuring opportunities, and similar transactions being accounted for differently? Eliminating that was supposed to be one of the big improvements of a new lease accounting standard. Will the two boards find a way to resolve the disagreement and keep a converged standard?
Stay tuned for more developments next month.
The boards considered two basic approaches. The first, which is the current methodology under FAS 13 and IAS 17, is derecognition: the owned asset is credited (reduced/eliminated). Under present accounting, the entire asset is derecognized, replaced by the receivable. Things get more complicated in the proposed new system, since many leases will be for only part of the value of the underlying asset. Crediting the asset would leave part of the owned asset on the books. More problematic is that multiple leases of a single asset could result in a sum total of receivables that is greater than the original asset value; how is that to be handled?
The solution the boards came up with was to create the concept of a performance obligation, representing the requirement to make the asset available to the lessee. This is a credit entry that is amortized over the life of the lease, based on passage of time or usage of the asset.
There have been rumblings for several months that several members of the boards are uncomfortable with the performance obligation methodology. Recent notes on lessor accounting have included explicit comment that decisions are “under the performance obligation approach.” At this week’s meetings, there was extensive discussion of going back to a derecognition approach, though this would be a “partial derecognition” approach. Described in detail in the agenda papers for the meetings, this means that the owned asset wouldn’t be completely taken off the books (unless the lease is for the entire useful life of the asset). A portion of the asset would be removed and replaced with the receivable.
The boards made decisions on how to account for various aspects of lessor activity under a partial derecognition approach, without committing to such an approach. You can read the full list of decisions in the FASB Action Alert. I’m not going to repeat all of it because it’s not clear if it will actually take effect, and I’d just be restating what they state there.
One significant implication of a partial derecognition approach is that a lessor could recognize a profit at the beginning of the lease (as is currently done with sales-type capital lessor accounting). The boards' prior decisions on lessor accounting with a performance obligation did not permit an up-front recognition of profit; instead, all income is to be recognized in the form of interest over the life of the lease. This has potentially a major impact on the reported profitability of manufacturers who lease their equipment. One can expect that they will lobby hard for a derecognition approach.
Conceptually, a derecognition approach seems to the staff to be more consistent with the lessee right-of-use approach. However, the unguaranteed residual value becomes much more significant in this approach, which can increase complexity.
The boards haven’t concluded which way to go, and significantly, there’s a difference of opinions between the boards. The FASB prefers to stick with the performance obligation methodology; the IASB prefers a hybrid model, using a performance obligation in some cases and derecognition in others. (The FASB Action Alert summary doesn't list the vote, but based on prior activity, I doubt it was unanimous with either board.) They’ve asked their staff to develop proposals to decide when to apply which model. But won’t that inevitably result in structuring opportunities, and similar transactions being accounted for differently? Eliminating that was supposed to be one of the big improvements of a new lease accounting standard. Will the two boards find a way to resolve the disagreement and keep a converged standard?
Stay tuned for more developments next month.
Tuesday, May 18, 2010
April meeting results
The FASB & IASB met again in mid-April for multiple meetings regarding the new lease accounting standard (originally supposed to be a joint meeting in London, the Icelandic volcano forced it to be a videoconference). Lessee topics included sale/leaseback transactions and rent presentation; subleasing was also discussed. Topics for lessors included: performance obligation amortization, impairment, purchase options, and disclosure requirements. Long-term leases of land affect both lessees and lessors.
Sale and leaseback transactions
Under current US GAAP, a sale and leaseback is recognized as such only if it meets criteria specified in FAS 98, which particularly prohibit “continuing involvement” by the seller-lessee in the property other than the leaseback itself. If there is continuing involvement, such as a fixed-price purchase option, nonrecourse financing, or a guaranteed residual, sale/leaseback accounting is prohibited and the transaction must be accounted for as a financing, with the asset remaining on the “seller’s” books.
The boards have decided to tie the definition of a qualifying transaction to their previous decision to account for a lease as a sale of the underlying asset. The relevant definition is “if at the end of the contract control of the underlying asset has been transferred and all but a trivial amount of the risks and benefits associated with the underlying asset have been transferred.” The interesting thing about use of this definition is that in this case, it’s being used to define the sale portion of the transaction, not the lease portion. The impact of the decision should be minimal; that is, generally transactions will get the same treatment (as far as whether they’re treated as sale/leaseback or as financing) under the new standard as the old, but it makes sense to use more consistent definitions within the new standard.
Lessee presentation of total cash rentals paid
Currently, cash rent paid under operating leases is a line item in the income statement; it is not, however, an income statement for capital leases (since the expenses recognized are interest and depreciation). The new standard includes a disclosure with a reconciliation of obligation to pay rentals, along with reporting interest and obligation repayments (separately) in the statement of cash flows; no separate presentation of total rent paid is to be included.
Subleases
As one might expect, a sublease is treated like a lessor lease by the intermediate party. Assets and liabilities for subleases will be reported gross with a net subtotal, separate from the assets and liabilities related to the head lease (the original lease of the asset that is being subleased).
Long-term leases of land
There had been some discussion of possibly treating long-term leases of land as sales (in some countries, land leases of 99 or even 999 years are common due to cultural or legal barriers to actual transfer of land ownership). The boards decided not to go that route; long-term land leases will be treated like any other lease within the new standard.
Lessor performance obligation amortization
Amortization should be in a systematic and rational manner based on the pattern of use of the underlying asset. This could be passage of time, hours of use or items produced for equipment, etc.
The boards have not decided whether or how to permit revenue recognition at the start of a lease (similar to current sales-type lessor lease accounting), and asked the staff to further analyze the issue.
Lessor accounting for purchase options
Purchase options are to be accounted for the same way as renewal and termination options, using the “more likely than not” criterion for exercise.
Lessor accounting for impairment of assets
The receivable is to be reviewed first for impairment, with an adjustment to both the receivable and the performance obligation and any difference being recorded in profit or loss. The underlying asset is also subject to impairment review; the staffs are to further consider how to apply IFRS 36 and ASC Topic 360, each board’s impairment standard.
Lessor disclosures
Descriptive
The nature of the lease arrangement(s), if leasing is a significant part of the lessor’s business activities
Restrictions placed on leased assets by the leases
Existence and terms of any residual value guarantees
Under IFRS: Information on risks surrounding the receivable (cf. IFRS 7)
Under US GAAP: Information on credit quality, the uncertainty of future cash flows, and how the lessor manages those uncertainties
Notation if simplified short-term lease accounting is being used
Quantitative
Maturity analysis, by year for five years and future years as a lump sum, showing the minimum contractual receivables and total estimated receivable
Maturity analysis, by year for three years and future years as a lump sum, of the satisfaction of performance obligations
Reconciliation between opening and closing balances for the receivable and performance obligation, showing the transactions resulting in increases and decreases
If simplified short-term accounting is being used, the gross amount so recognized
The FASB meeting notes indicate that the boards now anticipate a release of the exposure draft in August 2010, rather than the previously planned June. Obviously there’s too much yet to be completed.
This week (May 18 & 19), the boards have scheduled over 7 hours of meeting time to discuss a lessor’s accounting for the performance obligation and the alternative approach of derecognition (i.e., rather than keeping the leased asset on the books and setting up a performance obligation, the lessor would reduce reported owned assets by the amount of the lease receivable).
Sale and leaseback transactions
Under current US GAAP, a sale and leaseback is recognized as such only if it meets criteria specified in FAS 98, which particularly prohibit “continuing involvement” by the seller-lessee in the property other than the leaseback itself. If there is continuing involvement, such as a fixed-price purchase option, nonrecourse financing, or a guaranteed residual, sale/leaseback accounting is prohibited and the transaction must be accounted for as a financing, with the asset remaining on the “seller’s” books.
The boards have decided to tie the definition of a qualifying transaction to their previous decision to account for a lease as a sale of the underlying asset. The relevant definition is “if at the end of the contract control of the underlying asset has been transferred and all but a trivial amount of the risks and benefits associated with the underlying asset have been transferred.” The interesting thing about use of this definition is that in this case, it’s being used to define the sale portion of the transaction, not the lease portion. The impact of the decision should be minimal; that is, generally transactions will get the same treatment (as far as whether they’re treated as sale/leaseback or as financing) under the new standard as the old, but it makes sense to use more consistent definitions within the new standard.
Lessee presentation of total cash rentals paid
Currently, cash rent paid under operating leases is a line item in the income statement; it is not, however, an income statement for capital leases (since the expenses recognized are interest and depreciation). The new standard includes a disclosure with a reconciliation of obligation to pay rentals, along with reporting interest and obligation repayments (separately) in the statement of cash flows; no separate presentation of total rent paid is to be included.
Subleases
As one might expect, a sublease is treated like a lessor lease by the intermediate party. Assets and liabilities for subleases will be reported gross with a net subtotal, separate from the assets and liabilities related to the head lease (the original lease of the asset that is being subleased).
Long-term leases of land
There had been some discussion of possibly treating long-term leases of land as sales (in some countries, land leases of 99 or even 999 years are common due to cultural or legal barriers to actual transfer of land ownership). The boards decided not to go that route; long-term land leases will be treated like any other lease within the new standard.
Lessor performance obligation amortization
Amortization should be in a systematic and rational manner based on the pattern of use of the underlying asset. This could be passage of time, hours of use or items produced for equipment, etc.
The boards have not decided whether or how to permit revenue recognition at the start of a lease (similar to current sales-type lessor lease accounting), and asked the staff to further analyze the issue.
Lessor accounting for purchase options
Purchase options are to be accounted for the same way as renewal and termination options, using the “more likely than not” criterion for exercise.
Lessor accounting for impairment of assets
The receivable is to be reviewed first for impairment, with an adjustment to both the receivable and the performance obligation and any difference being recorded in profit or loss. The underlying asset is also subject to impairment review; the staffs are to further consider how to apply IFRS 36 and ASC Topic 360, each board’s impairment standard.
Lessor disclosures
Descriptive
The nature of the lease arrangement(s), if leasing is a significant part of the lessor’s business activities
Restrictions placed on leased assets by the leases
Existence and terms of any residual value guarantees
Under IFRS: Information on risks surrounding the receivable (cf. IFRS 7)
Under US GAAP: Information on credit quality, the uncertainty of future cash flows, and how the lessor manages those uncertainties
Notation if simplified short-term lease accounting is being used
Quantitative
Maturity analysis, by year for five years and future years as a lump sum, showing the minimum contractual receivables and total estimated receivable
Maturity analysis, by year for three years and future years as a lump sum, of the satisfaction of performance obligations
Reconciliation between opening and closing balances for the receivable and performance obligation, showing the transactions resulting in increases and decreases
If simplified short-term accounting is being used, the gross amount so recognized
The FASB meeting notes indicate that the boards now anticipate a release of the exposure draft in August 2010, rather than the previously planned June. Obviously there’s too much yet to be completed.
This week (May 18 & 19), the boards have scheduled over 7 hours of meeting time to discuss a lessor’s accounting for the performance obligation and the alternative approach of derecognition (i.e., rather than keeping the leased asset on the books and setting up a performance obligation, the lessor would reduce reported owned assets by the amount of the lease receivable).
Thursday, March 25, 2010
Revisiting lessor assets; presentation
A major change in proposed accounting under the new lease accounting standard hits the lessor balance sheet. Under FAS 13 and IAS 17, when a lessor has a capital lease, the underlying asset is removed from the books ("derecognized"), and is replaced with a receivable. For the new standard, the boards agreed (at June, July, and October meetings) to use a "performance obligation" concept; the original asset stays on the books unchanged, a receivable for the rents is set up, and the receivable is balanced by a performance obligation that is amortized over the life of the lease.
While this resolves the problem of a disappearing asset that the lessor still owns, it raises its own complications. One of the most serious is the impact on financial ratios; since a company normally has more assets than liabilities, putting an equal new asset and liability on the balance sheet erodes a company's financial ratio, resulting in the anomaly that a lessor looks like it's in worse financial shape when it successfully leases its assets (which in the real world is a healthy situation).
At the boards' March 23 meeting, they discussed dealing with this through net presentation, showing the performance obligation as a contra asset rather than a liability. However, during the discussion, the strong majority of the IASB expressed a preference to revisit the entire performance obligation concept and possibly jettison it for the old derecognition approach. (The FASB seemed more evenly split, and as this was a physical joint meeting in London, not all the FASB members were present.)
A major concern, however, is the timetable. The boards are trying very hard to keep to releasing an Exposure Draft by June 30, 2010, with a final standard by June 30, 2011. A number of board members felt it would be difficult or impossible to properly flesh out a derecognition model by June 30 to include in the Exposure Draft. One suggestion was to separate lessee and lessor accounting, releasing an Exposure Draft for lessee accounting on time with lessor accounting following a few months later, but before the expiration of the comment period for lessees so that people would have time to review both together and comment accordingly. (Side note: for the first time that I'm aware of, a board member commented on how long it might be until the new standard must be implemented, with a comment of "2, 3, or 4 years later." However, this was an off-the-cuff comment, so I have no idea how much weight to give it.) No decision was reached.
More generally, the March 23 meeting was focused on presentation.
Lessees:
While this resolves the problem of a disappearing asset that the lessor still owns, it raises its own complications. One of the most serious is the impact on financial ratios; since a company normally has more assets than liabilities, putting an equal new asset and liability on the balance sheet erodes a company's financial ratio, resulting in the anomaly that a lessor looks like it's in worse financial shape when it successfully leases its assets (which in the real world is a healthy situation).
At the boards' March 23 meeting, they discussed dealing with this through net presentation, showing the performance obligation as a contra asset rather than a liability. However, during the discussion, the strong majority of the IASB expressed a preference to revisit the entire performance obligation concept and possibly jettison it for the old derecognition approach. (The FASB seemed more evenly split, and as this was a physical joint meeting in London, not all the FASB members were present.)
A major concern, however, is the timetable. The boards are trying very hard to keep to releasing an Exposure Draft by June 30, 2010, with a final standard by June 30, 2011. A number of board members felt it would be difficult or impossible to properly flesh out a derecognition model by June 30 to include in the Exposure Draft. One suggestion was to separate lessee and lessor accounting, releasing an Exposure Draft for lessee accounting on time with lessor accounting following a few months later, but before the expiration of the comment period for lessees so that people would have time to review both together and comment accordingly. (Side note: for the first time that I'm aware of, a board member commented on how long it might be until the new standard must be implemented, with a comment of "2, 3, or 4 years later." However, this was an off-the-cuff comment, so I have no idea how much weight to give it.) No decision was reached.
More generally, the March 23 meeting was focused on presentation.
Lessees:
- Lease assets and obligations are to be reported separately from other assets and obligations in the statement of financial position (balance sheet).
- Lease amortization and interest expense can be separated from other amortization and interest expense either in the primary financials or in a footnote disclosure.
- Obligation and interest payments are to be listed separately in the statement of cash flows, in the financing activities section.
- The original leased asset, lease receivable, and performance obligation will be reported separately, then combined into a net lease asset or liability.
- Lease income and expense will be presented separately from other income and expense items. The FASB wants to combine these into a net lease income or expense; the IASB did not concur, which makes for a rare point of divergence in opinions. (Presumably a converged final standard will be reached after Exposure Draft comments are reviewed, as the boards have made a clear priority of having a converged standard.)
Thursday, October 29, 2009
FASB/IASB joint meeting
Earlier this week, the FASB and IASB held a joint meeting in London. Among the many topics discussed was leases. According to the Summary of Board Decisions, the following important decisions were made:
* The boards reaffirmed the right-of-use approach for lessees. (IOW, the pleas of many discussion paper comments to keep operating lease accounting have been rejected.)
* The boards have decided to accept the idea of "in substance purchases" as being different from leases; they will be excluded from the scope of lease accounting. Criteria will be developed to identify which contracts should be so treated.
* The boards agreed to use a performance obligation approach for lessor accounting--the asset is not removed from the books, but a liability is set up to reflect the obligation to permit use of the asset, balancing the receivable for the rental stream.
* Lessors will no longer be permitted to recognize a profit at the beginning of the lease; everything will be recognized over the lease term.
* A lease will now need to be reflected on the balance sheet (presumably for both lessees and lessors) as soon as the contract is signed, rather than the current practice of waiting until the asset is delivered. However, until delivery it is to be recognized "net" only, which means that in most cases there will be nothing to report (assets and liabilities are equal), except in case of an impairment. Disclosures (in footnotes, not the primary financials) would be required to detail the assets and liabilities, at least when there is a significant gap in time between signing and delivery and/or the amounts are significant.
The boards will discuss further issues in November, including
* initial and subsequent measurement of the asset and obligation
* treatment of leases with options
* contingent rentals and guaranteed residuals
* The boards reaffirmed the right-of-use approach for lessees. (IOW, the pleas of many discussion paper comments to keep operating lease accounting have been rejected.)
* The boards have decided to accept the idea of "in substance purchases" as being different from leases; they will be excluded from the scope of lease accounting. Criteria will be developed to identify which contracts should be so treated.
* The boards agreed to use a performance obligation approach for lessor accounting--the asset is not removed from the books, but a liability is set up to reflect the obligation to permit use of the asset, balancing the receivable for the rental stream.
* Lessors will no longer be permitted to recognize a profit at the beginning of the lease; everything will be recognized over the lease term.
* A lease will now need to be reflected on the balance sheet (presumably for both lessees and lessors) as soon as the contract is signed, rather than the current practice of waiting until the asset is delivered. However, until delivery it is to be recognized "net" only, which means that in most cases there will be nothing to report (assets and liabilities are equal), except in case of an impairment. Disclosures (in footnotes, not the primary financials) would be required to detail the assets and liabilities, at least when there is a significant gap in time between signing and delivery and/or the amounts are significant.
The boards will discuss further issues in November, including
* initial and subsequent measurement of the asset and obligation
* treatment of leases with options
* contingent rentals and guaranteed residuals
Thursday, August 27, 2009
Upcoming Leases Working Group meeting
When the FASB & IASB decided to revise the lease accounting standard back in 2006, they called for members of academia, public accounting, and the world of publicly held companies to volunteer to serve on an advisory panel, called the Leases Working Group. A first meeting was held in January 2007 to discuss the various issues surrounding lease accounting, and get the group's input on possible approaches to deal with the problems.
Then the boards seemed to forget the group existed. It has been over 2-1/2 years since the group met. Finally, on September 3, a second meeting of the Leases Working Group will be held in London. It's planned as an all-day event. Unlike IASB board meetings, this meeting will apparently not be available for live online listening; however, they have promised that audio will be available at a later time. Anyone who wants to attend the meetings live may do so, but needs to register in advance on the IASB website.
Agenda papers for the meeting are also available at the IASB website. They indicate that the issues to be discussed are largely issues that were not covered by the Preliminary Views discussion paper, though there will be a brief review of the 295 comment letters received. Instead, the topics to be discussed are mostly matters that the boards have discussed in their May, June, and July meetings: impairment, revaluation, initial direct costs, sale & leaseback transactions, transition, and lessor accounting, plus in-substance purchases, which some members feel should be accounted for differently than other leases. That has been mentioned at prior meetings, but there has been no in-depth discussion on the topic. Many of the topics for review are ones where the two boards have taken different positions; a number of comment letters urged the boards to come to an agreement on these topics (many respondents felt a unified standard was more important than which position was taken). More detailed information on the topics is available at the IASB's web site, among the agenda papers for prior board meetings (the appropriate papers are noted on p. 3 of the working group's agenda paper #1).
The working group will have to move at a fast pace; less than half an hour per issue has been allotted for the lessee topics, plus 90 minutes for lessor accounting and 45 minutes for in-substance purchases.
The boards plan to discuss the comment letters at meetings in September, and lessor accounting at October meetings. At this point, the schedule for the leases project still indicates an exposure draft in the second half of 2010, and a final standard in the first half of 2011. Whether the boards will stick with that after the September and October meetings, in the face of substantial public pressure for a simultaneous release of new lessee and lessor standards and a large amount of work to do on both sides of the transaction, remains to be seen.
Then the boards seemed to forget the group existed. It has been over 2-1/2 years since the group met. Finally, on September 3, a second meeting of the Leases Working Group will be held in London. It's planned as an all-day event. Unlike IASB board meetings, this meeting will apparently not be available for live online listening; however, they have promised that audio will be available at a later time. Anyone who wants to attend the meetings live may do so, but needs to register in advance on the IASB website.
Agenda papers for the meeting are also available at the IASB website. They indicate that the issues to be discussed are largely issues that were not covered by the Preliminary Views discussion paper, though there will be a brief review of the 295 comment letters received. Instead, the topics to be discussed are mostly matters that the boards have discussed in their May, June, and July meetings: impairment, revaluation, initial direct costs, sale & leaseback transactions, transition, and lessor accounting, plus in-substance purchases, which some members feel should be accounted for differently than other leases. That has been mentioned at prior meetings, but there has been no in-depth discussion on the topic. Many of the topics for review are ones where the two boards have taken different positions; a number of comment letters urged the boards to come to an agreement on these topics (many respondents felt a unified standard was more important than which position was taken). More detailed information on the topics is available at the IASB's web site, among the agenda papers for prior board meetings (the appropriate papers are noted on p. 3 of the working group's agenda paper #1).
The working group will have to move at a fast pace; less than half an hour per issue has been allotted for the lessee topics, plus 90 minutes for lessor accounting and 45 minutes for in-substance purchases.
The boards plan to discuss the comment letters at meetings in September, and lessor accounting at October meetings. At this point, the schedule for the leases project still indicates an exposure draft in the second half of 2010, and a final standard in the first half of 2011. Whether the boards will stick with that after the September and October meetings, in the face of substantial public pressure for a simultaneous release of new lessee and lessor standards and a large amount of work to do on both sides of the transaction, remains to be seen.
Thursday, July 30, 2009
Comment letters update, lessor accounting
The IASB continues to post comment letters to its web site. As I write this, the count stands at 272, with a notation that "Comment Letters are currently being uploaded to the website." However, fewer than 10 letters have been posted this week. It looks like these are letters received after the deadline, which they are choosing to still include (some of the cover letters have dates after July 17).
At a joint FASB/IASB meeting on July 23, the boards announced that they would review the comment letters at a meeting in September.
At the same meeting, the boards reached the following tentative decisions on lessor accounting (reported in the FASB Action Alert):
1. Initial measurement of the lessor’s right to receive rental payments would follow existing literature for the accounting for financial assets under either IFRSs or U.S. GAAP (IAS 39, Financial Instruments: Recognition and Measurement, for IFRSs and Section 310-10-30 of the FASB Accounting Standards Codification™ for U.S. GAAP).
2. Initial measurement of the lessor’s right to receive rental payments under U.S. GAAP would be discounted using the interest rate implicit in the lease.
3. Initial measurement of the lessor’s performance obligation would equal the customer consideration received (that is, on initial measurement the performance obligation would equal the lessor’s receivable).
4. Subsequent measurement of the lessor’s performance obligation would reflect decreases in the entity’s obligation to permit the lessee to use the leased item over the lease term.
However, they note that all of these decisions presuppose maintaining the overall concept of setting up a performance obligation for lessors (the original asset remains on the books, and a receivable is added to assets with a matching performance obligation as a liability). A number of comment letters have criticized that decision, in part because it seems not to mirror lessee accounting, and the boards have instructed their staffs to do additional analysis of a different model that would derecognize the asset to the extent of the lease. (This was the staff's preference presented to the boards at their May meetings, as previously mentioned on this blog.)
At a joint FASB/IASB meeting on July 23, the boards announced that they would review the comment letters at a meeting in September.
At the same meeting, the boards reached the following tentative decisions on lessor accounting (reported in the FASB Action Alert):
1. Initial measurement of the lessor’s right to receive rental payments would follow existing literature for the accounting for financial assets under either IFRSs or U.S. GAAP (IAS 39, Financial Instruments: Recognition and Measurement, for IFRSs and Section 310-10-30 of the FASB Accounting Standards Codification™ for U.S. GAAP).
2. Initial measurement of the lessor’s right to receive rental payments under U.S. GAAP would be discounted using the interest rate implicit in the lease.
3. Initial measurement of the lessor’s performance obligation would equal the customer consideration received (that is, on initial measurement the performance obligation would equal the lessor’s receivable).
4. Subsequent measurement of the lessor’s performance obligation would reflect decreases in the entity’s obligation to permit the lessee to use the leased item over the lease term.
However, they note that all of these decisions presuppose maintaining the overall concept of setting up a performance obligation for lessors (the original asset remains on the books, and a receivable is added to assets with a matching performance obligation as a liability). A number of comment letters have criticized that decision, in part because it seems not to mirror lessee accounting, and the boards have instructed their staffs to do additional analysis of a different model that would derecognize the asset to the extent of the lease. (This was the staff's preference presented to the boards at their May meetings, as previously mentioned on this blog.)
Monday, June 15, 2009
Proposed changes to lessor accounting
The FASB and IASB met separately on May 18 & May 20 (respectively) to discuss changes to lessor accounting consistent with the move to a right-to-use model for lease accounting. As previously discussed, the boards had decided to delay lessor accounting changes and move ahead with lessee accounting only, because they felt that the need for changes was more urgent for lessee accounting and lessor accounting had complexities that would slow the whole process down.
Now they're getting started with looking at lessor accounting directly, in part perhaps because they realized that sublease accounting is inevitably affected by lessee accounting, and sublease and lessor accounting are inextricably linked.
The boards dealt with a fundamental question in their approach to lessor accounting: Does a lease result in a transfer of a portion of the leased item from lessor to lessee, or does it create a new right and obligation for the lessor? Or as the staff puts it in their discussion paper, "What is the credit?" (Additional examples, with sample journal entries, are in a second discussion paper.) The debit in the transaction is clearly the creation of a receivable representing the discounted flow of rents. Should the credit be recognized as a reduction in the value of the asset on the lessor's books (a derecognition of part of the asset), or should the asset remain untouched and a separate performance obligation created to reflect the requirement to allow the lessee to use the asset?
The FASB staff, which wrote up the discussion paper, favored the first approach (Approach A), derecognizing a portion of the lessor's asset and keeping only the net on the lessor's books. However, the boards decided instead to recognize a performance obligation. The discussion at the IASB (available by webcast until August 19) raised a number of concerns with Approach A, one of the most compelling apparently being that it would result in a steadily diminishing asset on the books which could eventually go negative (if a building that is mostly depreciated, or land recorded at historical cost, is leased based on current market value). A separate but related issue was whether profit should be recognized at the inception of the lease. This is currently permitted for manufacturers and dealers under sales-type leases, but not for direct financing leases. A number of board members did not want to permit recognition of profit at inception, and Approach A was seen as facilitating or even demanding profit recognition. The FASB also preferred Approach B, with members stating their position in favor of no immediate profit recognition and keeping the full asset on the lessor's books as long as the lessor retains title. (A concern raised and not resolved by both boards was whether treatment should be different if the lease transfers ownership at the end of the lease term, so that no interest in the asset remains with the lessor.)
The boards remain concerned about opportunities for structuring transactions to avoid the regulations, and are trying to craft the new regulations to reduce the potential for structuring, ensuring that legal forms don't facilitate treating differently transactions of similar economic substance.
Next steps:
In meetings scheduled for July, the boards will discuss initial and subsequent measurement and presentation of the asset and liability, as well as how to recognize contingent rents and options. (The second discussion paper for the May meetings made assumptions for measurement, but these have not been decided on by the boards.) Additional items for discussion, not necessarily at the July meeting, include how to differentiate a sale of an asset from a lease, and whether the right-to-use model should apply to short-term and immaterial leases. Following that meeting, the boards will decide whether they have made enough progress on lessor accounting to include it in the Exposure Draft scheduled for mid-2010, or if the ED should remain lessee-only.
Now they're getting started with looking at lessor accounting directly, in part perhaps because they realized that sublease accounting is inevitably affected by lessee accounting, and sublease and lessor accounting are inextricably linked.
The boards dealt with a fundamental question in their approach to lessor accounting: Does a lease result in a transfer of a portion of the leased item from lessor to lessee, or does it create a new right and obligation for the lessor? Or as the staff puts it in their discussion paper, "What is the credit?" (Additional examples, with sample journal entries, are in a second discussion paper.) The debit in the transaction is clearly the creation of a receivable representing the discounted flow of rents. Should the credit be recognized as a reduction in the value of the asset on the lessor's books (a derecognition of part of the asset), or should the asset remain untouched and a separate performance obligation created to reflect the requirement to allow the lessee to use the asset?
The FASB staff, which wrote up the discussion paper, favored the first approach (Approach A), derecognizing a portion of the lessor's asset and keeping only the net on the lessor's books. However, the boards decided instead to recognize a performance obligation. The discussion at the IASB (available by webcast until August 19) raised a number of concerns with Approach A, one of the most compelling apparently being that it would result in a steadily diminishing asset on the books which could eventually go negative (if a building that is mostly depreciated, or land recorded at historical cost, is leased based on current market value). A separate but related issue was whether profit should be recognized at the inception of the lease. This is currently permitted for manufacturers and dealers under sales-type leases, but not for direct financing leases. A number of board members did not want to permit recognition of profit at inception, and Approach A was seen as facilitating or even demanding profit recognition. The FASB also preferred Approach B, with members stating their position in favor of no immediate profit recognition and keeping the full asset on the lessor's books as long as the lessor retains title. (A concern raised and not resolved by both boards was whether treatment should be different if the lease transfers ownership at the end of the lease term, so that no interest in the asset remains with the lessor.)
The boards remain concerned about opportunities for structuring transactions to avoid the regulations, and are trying to craft the new regulations to reduce the potential for structuring, ensuring that legal forms don't facilitate treating differently transactions of similar economic substance.
Next steps:
In meetings scheduled for July, the boards will discuss initial and subsequent measurement and presentation of the asset and liability, as well as how to recognize contingent rents and options. (The second discussion paper for the May meetings made assumptions for measurement, but these have not been decided on by the boards.) Additional items for discussion, not necessarily at the July meeting, include how to differentiate a sale of an asset from a lease, and whether the right-to-use model should apply to short-term and immaterial leases. Following that meeting, the boards will decide whether they have made enough progress on lessor accounting to include it in the Exposure Draft scheduled for mid-2010, or if the ED should remain lessee-only.
Thursday, March 26, 2009
International Lease Finance in trouble
The Wall Street Journal reports that the world's biggest lessor of airplanes, International Lease Finance Corp., says in a recent filing that its financing needs could threaten its survival. ILFC is a (profitable) part of AIG, and AIG's woes have been impairing its ability to borrow money to finance its purchases of planes, which it leases to many of the world's airlines. ILFC owns 955 planes worth $50 billion. It had been using commerical paper for a lot of its financing, but with the cut in credit ratings it has suffered as part of AIG, that market is now closed.
The article speculates that ILFC is too big to fail, as it's the largest customer for both Boeing and Airbus (not to mention the prime supplier of airplanes to numerous airlines). AIG is trying to sell ILFC to raise money to repay their borrowings from the feds.
The article speculates that ILFC is too big to fail, as it's the largest customer for both Boeing and Airbus (not to mention the prime supplier of airplanes to numerous airlines). AIG is trying to sell ILFC to raise money to repay their borrowings from the feds.
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