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.

May redeliberations

The FASB/IASB joint meeting on May 20-22, 2014, reached the following additional decisions for the new lease accounting standard, reviewing the Revised Exposure Draft (RED) and redeliberating on user reactions:

• Allocating consideration between lease and non-lease components should be based on observable standalone prices, if available, or the best estimate. If the lease term or an option is reassessed, the allocation should also be reassessed.

• Lessors may choose to make an accounting policy by class of underlying asset not to separate lease & non-lease components, and instead treat as a single lease component.

Other decisions were made basically reaffirming and clarifying the RED on the definition of a lease, separating lease and non-lease components (other than discussed above), and initial direct costs. Of note is the reaffirmation that initial direct costs include only incremental costs associated with starting a lease. Current US GAAP permits lessors to allocate overhead costs to a lease, which would now be prohibited.

For more details, see the FASB board meeting minutes or IAS Plus.

It's also worth noting that the boards on May 28 released the new converged standard on revenue recognition (RevRec). This standard will be referenced in the new lease accounting standard for some aspects of lessor accounting, as previously noted. It is also notable for its implementation schedule: required in 2017. Multiple observers of the boards think that the same implementation schedule will apply to leases, though obviously the final standard has not been released, and won't be for several months. The boards haven't yet posted a timetable for final release, but some observers think it will be this year.

On May 29, Hans Hoogervorst, chairman of the IASB, spoke to the IFRS Conference in Singapore. Among his comments, he said he expected to complete work on the lease accounting standard "in the next couple of months," while saying they're still looking at ways to make implementation less costly but suggesting that most companies will not be significantly affected.

Two expense profiles

At the joint meeting of the IASB & FASB yesterday (June 13), the boards came to an agreement on the expense recognition patterns for lessee leases to be presented in the Revised Exposure Draft (RED). (My thanks to Asset Finance International for their summary of the board meeting.) If you're looking at the meeting papers prepared by the staff (available here), the choice made was for Approach 3, meaning that some leases will be accounted for using current finance/capital lease accounting (recognizing interest and depreciation expense, with the effect that expenses are higher at the beginning of the lease), while others will be accounted for with a single lease expense item which is recognized straight line over the life of the lease. If the rent payments are equal over the life of the lease, the asset and liability balances will be equal at any date. If they are unequal, the adjustment required to balance cash rent vs. accrual expense (what is shown under current operating lease accounting as a deferred rent liability) will be taken to the asset. The asset will also be adjusted for any initial direct costs or impairments, both of which are to be recognized over the life of the lease (or remaining life, for an impairment).

The second decision was where to draw the line between the two types of expense recognition. The boards opted for Option 3 (as described in agenda paper 3D/237):

(a) Leases of property (defined as land or a building – or part of a building – or both) should be accounted for using a straight-line presentation in the income statement ... unless:
(i) The lease term is for the major part of the economic life of the underlying asset; or
(ii) The present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset.

(b) Leases of assets other than property should be accounted for under Approach 1 [finance accounting] ... unless:
(i) The lease term is an insignificant portion of the economic life of the underlying asset;
(ii) The present value of the fixed lease payments is insignificant relative to the fair value of the underlying asset.

The boards' push for convergence was in evidence in the voting. A solid majority of the IASB preferred a single methodology for all leases, using finance lease accounting. However, members of the FASB very strongly felt that straight line expensing was a necessary part of the standard, and the IASB agreed in the interest of having a common standard.

The implications are that virtually all equipment (except leases of 12 months or less, which have previously been excluded from the standard and will be treated like current operating leases) will use finance accounting, while the vast majority of property leases will use straight line accounting. Only when a property lease is for nearly all of an asset's useful life (or there is an ownership transfer or bargain purchase option) will finance accounting be used. We'll have to see how this sorts out in practice, but this probably means that a lease of a building for less than 30 or 40 years will use straight line unless there are very special circumstances.

Lessor accounting

Having made that decision, the boards discussed the implications for lessors. Since they previously decided that lessors of "investment property" could use operating lease accounting, and this would cover virtually all property lessors, the focus was on equipment lessors. The boards decided that they would use accounting more or less symmetrical with lessee accounting, so the "receivable and residual" model will apply to equipment leases unless the lease has an "insignificant" term or receivable. This is similar to current capital lessor accounting, but with the benefit to lessors that they are permitted to recognize a portion of profit at inception (proportional to the value of the receivable compared to the residual), whereas currently profit is recognized over the life of the lease.

Next steps

There will be some wrap-up decisions to make at the July joint boards meeting, related to the RED comment period, transition, and disclosure adjustments. After that, the staff will prepare the RED, with the expectation that it will be released in Q4 2012. (If no further hitches come up, early in the quarter would seem likely.) With an expected 4-month comment period, then time to redeliberate based on comments received, a mid-year 2013 release date of the new standard seems possible, unless there's strong pushback. However, the boards seem to have met the biggest objections, so I think any changes this time around are likely to be modest (tweaks of wording, adjustments of disclosures, etc.), not the wholesale rewrite that we got between the original ED and the RED.

At this point, I wouldn't expect an effective date before 2016, to allow companies time to update their systems and gather any needed information. However, the requirement to restate prior years remains, so U.S. companies will generally need to recalculate 2014 & 2015 when they first apply the standard in 2016. If early implementation is permitted, the recalculation period would move forward commensurately. In other words, 2016 isn't that far away.

EZ13

Here at Financial Computer Systems, we're finishing up the latest update of EZ13, which will be released this summer. We won't have the new level expense capital methodology in that version, but will be working on it later this year. We'll have it in place, including transitions from current accounting, long before implementation is required. We do right now provide for pro forma capitalizing operating leases according to current capitalization rules, so you can see what your balance sheet exposure is under the RED.

Exposure Draft delayed to 2012

The FASB & IASB have updated their project schedules to indicate that the revised exposure draft (RED) will be released in Q1 2012. That's another delay of three months from what was expected when they announced in July that a RED would be released. The Equipment Lease and Financing Association is reporting that the comment period will be a full 120 days; there had been speculation that the comment period might be shorter the second time around. That means that the comment period won't end until near the end of Q2. With time for redeliberation, that suggests that the final standard won't be out until late in 2012.

It's yet the latest delay in an oft-delayed project. When originally announced back in 2006, the boards expected to be done in 2009. The latest delay could affect the implementation date; speculation recently has focused on 2015 as the implementation date, but given the planned requirement to restate the prior two years of comparable financials, that means there could be just weeks between the release of the standard and when (1/1/2013) leases will effectively need to be reported under it. During those two years until actual implementation, bookings will be done under current standards, but companies will need to make sure they keep complete information on their leases to enable recreating their accounting under the new methodology. Of course, with the active consideration of full retrospective accounting (though probably not to be required, just optional), it would be good to be keeping information right now on any leases that you expect to remain active into 2015. (It is expected that leases that expire before implementation won't need to be recalculated.)

The boards held a lengthy meeting this week on leases, but I don't have time to review the 5 hours of recordings, and my normal sources haven't yet posted summaries of the events.

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.

Does the new leasing standard already apply?

The Exposure Draft of the proposed new lease accounting standard doesn't state the date that financial reporting will need to be prepared in accordance with the new standard. That date remains to be determined, and in the Basis for Conclusions, the boards say that they plan to consider the entire group of new standards for collective application (the FASB reports at least 14 active convergence projects with the IASB). In an online webinar, a staff member said that the boards recognize that a substantial amount of time will be needed for implementation. Discussion I've heard indicates that it wouldn't be before 2013.

The twist, however, is that paragraph 88 of the Exposure Draft states, "the date of initial application is the beginning of the first comparative period presented in the first financial statements in which the entity applies this guidance." All companies as far as I know report at least one prior year for comparison; some report multiple years. So if the standard applies to 2013 annual reports, and you report one prior year for comparison, your date of initial application (i.e., the date as of which you have to capitalize operating leases and renewal options) would be 1/1/2012. If you report three prior years for comparison, you may already be past the date of initial application of the new standard.