The FASB & IASB will have a joint meeting in London on Wednesday, January 19, when they will begin to discuss comments received on the Exposure Draft, and their plan for redeliberations. On Wednesday and Thursday, they will discuss 1) distinguishing leases from services, and 2) lessor accounting. They are not planning to make decisions on those topics.
The IASB meeting page for January has agenda papers for the leases discussions. These include a list of the major issues that the staffs feel should be thoroughly reconsidered, and a secondary list of additional possible issues for reconsideration. Five major issues are noted:
1) Definition of a lease (particularly differentiating from service/executory contracts)
2) Lessor accounting model
3) Lease term (i.e., when to include renewal options)
4) Variable lease payments (i.e., contingent rentals)
5) Profit & loss recognition pattern (whether asset amortization should be adjusted so that overall expense/income for leases is straight-line rather than front-loaded)
A laundry list of other items is listed as potentially needing reconsideration, including scope exclusions, short-term leases, foreign exchange, disclosure, fully retrospective application, lease incentives, and leasehold improvements, among numerous others.
The staffs' comment letter summary notes the "very high" number of responses (760 letters as of Jan. 12), and the fact that the boards have had contacts with several thousand people through various outreach activities. They note that very few financial statement users sent in comment letters, but outreach events included over 500 users.
The summary indicates that almost all comment letter writers disagreed with defining the lease term as the longest possible term more likely than not to occur. Respondents generally suggested either the current standard of including options that are "reasonably assured/reasonably certain" (current US GAAP/IFRS terminology), or "virtually certain" (seen as an even higher threshold), or the Alternative View listed in the IFRS Exposure Draft, to include options only when there are incentives to exercise those options.
The summary indicates likewise almost total disagreement with the contingent rent proposal. Alternative approaches suggested included 1) capitalizing only contingent rents based on an index or rate, 2) including only those that are outside an entity's control, or 3) using a different estimation approach (such as "best estimate" rather than "expected value" with multiple scenarios).
The summary is 70 pages long, so trying to fully recap it here would be tedious. Suffice to say that every question that the boards asked in the ED received lots of comment, with numerous alternatives presented.
Over half of the respondents were preparers of financial statements, with sizable numbers of industry organizations, individuals, and professional organizations. Half came from North America, a bit more than a quarter from Europe. The largest industries represented were financial services (almost 1/4), retail, real estate, and transportation.
Friday, January 14, 2011
Tuesday, January 11, 2011
Volume of comment letters
How does the volume of comment letters on the proposed lease accounting standard compare to other recent exposure drafts? The following list may be of interest:
Leases: 746 (and counting)
Fair value measurement: 95
Comprehensive Income: 72
Accounting for Financial Instruments: 2814
Derivative Instruments and Hedging Activities: 127
Amortised Cost and Impairment: 179
Revenue Recognition: 971
Troubled Debt Restructuring: 117
So leases isn't the biggest, but it's up there.
Leases: 746 (and counting)
Fair value measurement: 95
Comprehensive Income: 72
Accounting for Financial Instruments: 2814
Derivative Instruments and Hedging Activities: 127
Amortised Cost and Impairment: 179
Revenue Recognition: 971
Troubled Debt Restructuring: 117
So leases isn't the biggest, but it's up there.
"It's not a done deal."
That was the statement of Larry Smith, FASB board member, at last Thursday's (Jan. 6) afternoon roundtable discussion on the proposed new lease accounting standard. He was responding to one participant's comment that people in the leasing industry he's talked to thought there was no point in submitting a comment letter or otherwise participating in the boards' outreach activities, because they thought the standard was "a done deal" and the process was just for show. Smith was emphatic in denying that. New FASB Chairman Leslie Seidman concurred, adding, "I've already decided that I will change my position on one or two matters," and suggesting that she may make further changes based on additional review of the comment letters and discussion with interested parties.
The count of comment letters is now up to 746 (including letters received after the deadline, which are still being posted to the FASB website). I can't possibly read them all (I need to do my real job), but members of the FASB and IASB staff are. I spoke to one of the FASB staff who is personally reading every single comment letter on lease accounting, and commented that the letters are substantive (and lengthy); they're impressed by the thoughtful responses presented. I'm sure it'll be a few more weeks before they have compiled a summary for the boards, and the boards can begin redeliberations.
I attended the Thursday afternoon roundtable as an invited participant. Other participants included representatives of KPMG and Ernst & Young, lessors Xerox and International Lease Finance (one of the largest aviation lessors in the world), the CFA Institute (financial analyst, and thus a user of financial statements), Toys R Us, Transocean (the world's largest drilling rig operator, unfortunately now infamous as the driller of the BP well that blew up last year), and consultants to the leasing industry. Also present were all five members of the FASB board, as well as two IASB members and several staff members from both boards.
We had four planned topics of discussion: the definition of a lease, the lessor accounting model, the lease term, and variable lease payments (i.e., contingent rents). Most of the discussion of the definition of a lease centered on the distinction from service contracts. It was noted that the line is sometimes fuzzy even today, but because operating leases and service contracts are accounted for relatively similarly, differentiating them isn't a significant issue. With capitalization of leases, the difference becomes much more significant. Transocean is concerned that they may be seen as lessors, which they haven't been up to now, for contracts which include use of a drilling rig, but provide full crew and other services. Airlines similarly may lease aircraft with crew & maintenance included (a "wet lease") or just the aircraft alone ("dry lease"). Aviation lessees and lessors are concerned that fully capitalizing a wet lease will reduce comparability. No consensus was reached about how or whether to divide services and leases.
We also briefly discussed whether the scope exclusion for "in-substance purchases" should be maintained, with some feeling it was a leftover in the proposal: it was set up when the boards were planning to provide only a performance obligation approach to lessor accounting, and lessors wanted a way to recognize up-front profit if they were effectively selling an asset. With the inclusion of the derecognition model, there seems to be less reason to have a separate methodology for in-substance purchases.
For the lessor accounting model, some prefer performance obligation, some prefer derecognition, and some see a place for both. But a number of participants essentially felt, "If it ain't broke, don't fix it." They don't see significant problems with current lessor accounting, and suggested essentially keeping it in place, with removal of FAS 13's "bright lines" differentiating capital and operating leases (i.e., using IAS 17 terminology of "the lease term is for the major part of the economic life" and "the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset"). The boards seemed to be willing to seriously consider that. Some participants noted that it was important to make this a long-term rather than interim decision (i.e., don't just tweak it until they can revisit it in a few years; if a change is required, do it now).
We spent long enough on these topics that our discussion leader (the FASB staff project manager for leases) decided to combine the issues of the lease term and variable payments, feeling they were in many respects similar. I agreed; in both cases, the boards are calling for capitalization of amounts that don't meet their own definition of a liability. We discussed the operational difficulty of making and updating the estimates for portfolios of thousands of leases. One FASB board member brought up a suggestion, apparently received in another venue, of doing the estimates on a whole portfolio basis rather than lease by lease. Roundtable participants felt that would not be workable, since in many cases there is wide variation in types of leases or characteristics of leases (real estate leases in particular are rarely cookie-cutter). The accountants also felt that such estimates would not be auditable.
The financial analyst expressed interest in an "expected value" approach, but other participants were extremely negative about booking, for instance, fractional lease terms (like a 7.2 year lease for a 5-year lease with several yearly renewal options). I argued that there is a qualitative difference between a 15-year lease and a 1-year lease with 14 yearly renewal options, since the lessee has the flexibility to walk away with no penalty. The current proposal makes those look identical if the renewals are judged "more likely than not," which penalizes the lessee and understates the lessor's risk of nonrenewal (and a nonrenewal would inevitably result in a substantial hit to the lessor's income statement, meaning potential for substantial earnings volatility). Options aren't "structuring;" they provide choices.
For contingent rents, a best estimate was seen as more tolerable than the current "reasonable number of estimates" (what's a reasonable number? does the norm vary from country to country?), though still all the participants in the room other than the analyst were opposed to capitalizing most contingent rents as well as the "more likely than not" threshold for including renewal options in the lease term. People were also opposed to using forward rates to estimate contingent rents that are based on an index or rate, considering it needlessly complex (do you use a different estimated rate for each monthly payment out five years or more?).
The three hours went quickly. Larry Smith of the FASB commented at the end, "We will take time." While the boards' goal has been to complete the project by June 2011, he said that has always been subject to the extent and nature of comment letters and other outreach responses, and they will extend the schedule if needed to properly respond. Their goal is a "comprehensive, converged, improved, and able to be implemented standard."
I definitely felt the board members were listening with open minds. It remains to be seen how they will balance the various perceived needs, and the varying purposes of leasing. One of the fundamental issues they're dealing with is that sometimes leasing is equivalent to purchasing an asset (a computer lease is perhaps the best example, given the short economic life of a computer), while at other times it's closer to provision of a service (a copier lease with low fixed charges and a per-page price). A methodology that provides comparability to one form doesn't work well for the other. But there are so many gradations between that it's hard to define a principle, any more than a bright line, that differentiates them.
Many people are concerned that whatever change the boards make will mess up their current business operations. Yet doing nothing means that true liabilities of a company are largely hidden (as the financial analyst put it, "Disclosure is not enough"). I don't think the boards will back down from requiring lessees to capitalize virtually all leases. But the rest of the standard is certainly in question, and the deliberations this spring are likely to be lengthy and contentious. Stay tuned!
The count of comment letters is now up to 746 (including letters received after the deadline, which are still being posted to the FASB website). I can't possibly read them all (I need to do my real job), but members of the FASB and IASB staff are. I spoke to one of the FASB staff who is personally reading every single comment letter on lease accounting, and commented that the letters are substantive (and lengthy); they're impressed by the thoughtful responses presented. I'm sure it'll be a few more weeks before they have compiled a summary for the boards, and the boards can begin redeliberations.
I attended the Thursday afternoon roundtable as an invited participant. Other participants included representatives of KPMG and Ernst & Young, lessors Xerox and International Lease Finance (one of the largest aviation lessors in the world), the CFA Institute (financial analyst, and thus a user of financial statements), Toys R Us, Transocean (the world's largest drilling rig operator, unfortunately now infamous as the driller of the BP well that blew up last year), and consultants to the leasing industry. Also present were all five members of the FASB board, as well as two IASB members and several staff members from both boards.
We had four planned topics of discussion: the definition of a lease, the lessor accounting model, the lease term, and variable lease payments (i.e., contingent rents). Most of the discussion of the definition of a lease centered on the distinction from service contracts. It was noted that the line is sometimes fuzzy even today, but because operating leases and service contracts are accounted for relatively similarly, differentiating them isn't a significant issue. With capitalization of leases, the difference becomes much more significant. Transocean is concerned that they may be seen as lessors, which they haven't been up to now, for contracts which include use of a drilling rig, but provide full crew and other services. Airlines similarly may lease aircraft with crew & maintenance included (a "wet lease") or just the aircraft alone ("dry lease"). Aviation lessees and lessors are concerned that fully capitalizing a wet lease will reduce comparability. No consensus was reached about how or whether to divide services and leases.
We also briefly discussed whether the scope exclusion for "in-substance purchases" should be maintained, with some feeling it was a leftover in the proposal: it was set up when the boards were planning to provide only a performance obligation approach to lessor accounting, and lessors wanted a way to recognize up-front profit if they were effectively selling an asset. With the inclusion of the derecognition model, there seems to be less reason to have a separate methodology for in-substance purchases.
For the lessor accounting model, some prefer performance obligation, some prefer derecognition, and some see a place for both. But a number of participants essentially felt, "If it ain't broke, don't fix it." They don't see significant problems with current lessor accounting, and suggested essentially keeping it in place, with removal of FAS 13's "bright lines" differentiating capital and operating leases (i.e., using IAS 17 terminology of "the lease term is for the major part of the economic life" and "the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset"). The boards seemed to be willing to seriously consider that. Some participants noted that it was important to make this a long-term rather than interim decision (i.e., don't just tweak it until they can revisit it in a few years; if a change is required, do it now).
We spent long enough on these topics that our discussion leader (the FASB staff project manager for leases) decided to combine the issues of the lease term and variable payments, feeling they were in many respects similar. I agreed; in both cases, the boards are calling for capitalization of amounts that don't meet their own definition of a liability. We discussed the operational difficulty of making and updating the estimates for portfolios of thousands of leases. One FASB board member brought up a suggestion, apparently received in another venue, of doing the estimates on a whole portfolio basis rather than lease by lease. Roundtable participants felt that would not be workable, since in many cases there is wide variation in types of leases or characteristics of leases (real estate leases in particular are rarely cookie-cutter). The accountants also felt that such estimates would not be auditable.
The financial analyst expressed interest in an "expected value" approach, but other participants were extremely negative about booking, for instance, fractional lease terms (like a 7.2 year lease for a 5-year lease with several yearly renewal options). I argued that there is a qualitative difference between a 15-year lease and a 1-year lease with 14 yearly renewal options, since the lessee has the flexibility to walk away with no penalty. The current proposal makes those look identical if the renewals are judged "more likely than not," which penalizes the lessee and understates the lessor's risk of nonrenewal (and a nonrenewal would inevitably result in a substantial hit to the lessor's income statement, meaning potential for substantial earnings volatility). Options aren't "structuring;" they provide choices.
For contingent rents, a best estimate was seen as more tolerable than the current "reasonable number of estimates" (what's a reasonable number? does the norm vary from country to country?), though still all the participants in the room other than the analyst were opposed to capitalizing most contingent rents as well as the "more likely than not" threshold for including renewal options in the lease term. People were also opposed to using forward rates to estimate contingent rents that are based on an index or rate, considering it needlessly complex (do you use a different estimated rate for each monthly payment out five years or more?).
The three hours went quickly. Larry Smith of the FASB commented at the end, "We will take time." While the boards' goal has been to complete the project by June 2011, he said that has always been subject to the extent and nature of comment letters and other outreach responses, and they will extend the schedule if needed to properly respond. Their goal is a "comprehensive, converged, improved, and able to be implemented standard."
I definitely felt the board members were listening with open minds. It remains to be seen how they will balance the various perceived needs, and the varying purposes of leasing. One of the fundamental issues they're dealing with is that sometimes leasing is equivalent to purchasing an asset (a computer lease is perhaps the best example, given the short economic life of a computer), while at other times it's closer to provision of a service (a copier lease with low fixed charges and a per-page price). A methodology that provides comparability to one form doesn't work well for the other. But there are so many gradations between that it's hard to define a principle, any more than a bright line, that differentiates them.
Many people are concerned that whatever change the boards make will mess up their current business operations. Yet doing nothing means that true liabilities of a company are largely hidden (as the financial analyst put it, "Disclosure is not enough"). I don't think the boards will back down from requiring lessees to capitalize virtually all leases. But the rest of the standard is certainly in question, and the deliberations this spring are likely to be lengthy and contentious. Stay tuned!
Thursday, December 30, 2010
The flood of comment letters
As of today, 697 comment letters have been posted responding to the exposure draft on Lease Accounting. The IASB has decided that they couldn't host all the comment letters; instead, you need to go to the FASB's web site to view those numbered 248 and higher (letters 1-247 are available on both sites). Some of the letters were received after the deadline, but have still been accepted.
There are far too many comment letters for me to review them all. But I think it's fair to say that the overwhelming majority object to including renewal options in the calculated lease term using the "more likely than not to be renewed" criterion, and to including most contingent rents in the capitalized rent stream. Many respondents are concerned about the cost of initial and ongoing implementation of the new standard (particularly if lease term and contingent rents need to be estimated and capitalized); many also think the new proposed methodology is inconsistent with their business models. Many are also concerned about the impact of reclassifying rent expense into amortization and interest expense, since the new classification moves the cost out of EBITDA (earnings before interest, taxes, depreciation, and amortization), which is an important metric for many companies. Other concerns expressed include the timing of expense recognition (front-loaded under the new model, as opposed to level under current operating lease accounting), potential for violation of debt covenants because companies will be reporting more debt, difficulty of getting expense reimbursements on cost-based contracts, and volatility of earnings (if the lease term & contingent rent proposals are maintained).
The lessor accounting proposal has varied reactions. Some agree with the proposal. Others think derecognition should be used for all lessor leases. One common complaint about the performance obligation approach is that it leads to double-counting (or even triple-counting) of assets: the lessor maintains the original asset on the books, sets up a lease receivable (another asset), and the lessee recognizes an asset for the right-of-use as well. The impact of double-counting for the lessor is mitigated by the proposal to report PO leases net (receivable minus PO), but it still seems conceptually strange to many people. It is also noted that the PO approach does not mirror lessee accounting.
The volume and vehemence of disagreement raises the bar, in my opinion, on review by the boards. We'll see what comes in the next few months.
There are far too many comment letters for me to review them all. But I think it's fair to say that the overwhelming majority object to including renewal options in the calculated lease term using the "more likely than not to be renewed" criterion, and to including most contingent rents in the capitalized rent stream. Many respondents are concerned about the cost of initial and ongoing implementation of the new standard (particularly if lease term and contingent rents need to be estimated and capitalized); many also think the new proposed methodology is inconsistent with their business models. Many are also concerned about the impact of reclassifying rent expense into amortization and interest expense, since the new classification moves the cost out of EBITDA (earnings before interest, taxes, depreciation, and amortization), which is an important metric for many companies. Other concerns expressed include the timing of expense recognition (front-loaded under the new model, as opposed to level under current operating lease accounting), potential for violation of debt covenants because companies will be reporting more debt, difficulty of getting expense reimbursements on cost-based contracts, and volatility of earnings (if the lease term & contingent rent proposals are maintained).
The lessor accounting proposal has varied reactions. Some agree with the proposal. Others think derecognition should be used for all lessor leases. One common complaint about the performance obligation approach is that it leads to double-counting (or even triple-counting) of assets: the lessor maintains the original asset on the books, sets up a lease receivable (another asset), and the lessee recognizes an asset for the right-of-use as well. The impact of double-counting for the lessor is mitigated by the proposal to report PO leases net (receivable minus PO), but it still seems conceptually strange to many people. It is also noted that the PO approach does not mirror lessee accounting.
The volume and vehemence of disagreement raises the bar, in my opinion, on review by the boards. We'll see what comes in the next few months.
Tuesday, December 14, 2010
More comment letters and other discussion
Comment letters on the proposed new lease accounting standard continue to come in to the boards. Tomorrow (Dec. 15) is the official deadline to submit a comment (though for the preliminary views document, they did continue to accept and post letters received later). Surprisingly, only a handful of letters have been posted since late last week. I have to think that reflects delays, not actual numbers of letters. As I write this, the count of letters posted is 114.
Few if any of the letters agree completely with the boards, and many vehemently oppose some or many of the provisions, on conceptual grounds (such as arguing that unexercised options are not liabilities), on practical grounds (complying will be burdensome for little perceived benefit), and for their implications (loan covenants will be breached, cost recovery contracts that are based on operating leases will be invalidated, etc.). Several are calling for delaying release until the standard can be thoroughly reviewed and reworked, particularly on the lessor side; others are calling for a lengthy implementation period (up to 5 years).
There are so many different objections it'll be a major task for the boards' staff to organize them, not to mention for the boards to consider them. A number of complaints refer to the impact on very specific situations of individual industries ("wet" vs. "dry" leases of planes and ships, for instance, meaning leases that do or don't include personnel to operate the vehicle). Many complain that the proposed standard will harm their business model; numerous letters suggest that the current economic downturn will be further extended because of it.
Asset Finance International reports that at a Nov. 5 meeting in London between lessors and members of the IASB, an IASB member stated that the boards weren't open to reconsidering the capitalization of lessee leases, but that they were willing to reconsider how to measure the asset, including the question of options and contingent rents.
The boards have indicated that they will consider carefully comments and suggestions made at the roundtable discussions scheduled for both in London & Hong Kong later this month and early January in the U.S. I will be participating in the afternoon session on Jan. 6, 2011, in Norwalk, CT (the FASB's headquarters).
Few if any of the letters agree completely with the boards, and many vehemently oppose some or many of the provisions, on conceptual grounds (such as arguing that unexercised options are not liabilities), on practical grounds (complying will be burdensome for little perceived benefit), and for their implications (loan covenants will be breached, cost recovery contracts that are based on operating leases will be invalidated, etc.). Several are calling for delaying release until the standard can be thoroughly reviewed and reworked, particularly on the lessor side; others are calling for a lengthy implementation period (up to 5 years).
There are so many different objections it'll be a major task for the boards' staff to organize them, not to mention for the boards to consider them. A number of complaints refer to the impact on very specific situations of individual industries ("wet" vs. "dry" leases of planes and ships, for instance, meaning leases that do or don't include personnel to operate the vehicle). Many complain that the proposed standard will harm their business model; numerous letters suggest that the current economic downturn will be further extended because of it.
Asset Finance International reports that at a Nov. 5 meeting in London between lessors and members of the IASB, an IASB member stated that the boards weren't open to reconsidering the capitalization of lessee leases, but that they were willing to reconsider how to measure the asset, including the question of options and contingent rents.
The boards have indicated that they will consider carefully comments and suggestions made at the roundtable discussions scheduled for both in London & Hong Kong later this month and early January in the U.S. I will be participating in the afternoon session on Jan. 6, 2011, in Norwalk, CT (the FASB's headquarters).
Tuesday, November 30, 2010
Our comment letter posted
The count of comment letters on the lease accounting standard is now up to 60, with a little more than two weeks to go. Our comment letter is #58.
Monday, November 22, 2010
Comment letters coming in
The lease accounting exposure draft has already received 45 comment letters, with almost a month to go until the deadline (Dec. 15). By comparison, the March 2009 discussion paper had received just 5 comment letters a month before its deadline. Since the DP got 302 responses, one can fairly expect a considerably larger number of responses to the ED. I don't know an easy way to compare with responses to other EDs, but I think it's fair to guess that this will be one of the more heavily commented on.
All or almost all letters from companies that will need to comply, and many of those from independent accountants, disagree with the proposal to capitalize renewal options and contingent rentals (unless the contingent rentals are disguised minimum lease payments). They make three basic arguments: options that haven't been exercised don't meet the conceptual definition of a liability, the estimates will be highly subjective guesswork, and the burden of complying will be onerous (for questionable benefit).
Some companies argue for keeping operating lease accounting, saying that it better matches expenses to benefits (capitalization results in more expense in the early years of a lease, less at the end, due to the interest method of amortizing the liability).
A number of lessors (and some users of statements) dislike the performance obligation approach, because it is asymmetrical with lessee accounting, it double-counts assets (though the ED calls for the final presentation in the financial statements to be net), and they're concerned that the dividing line between performance obligation and derecognition will be arbitrary. Most would prefer derecognition for all lessor leases, except for short-term leases. I haven't seen any deal with the issue of a re-leased asset that has been fully derecognized.
Will the boards bend to the complaints?
It's not too late for you to add your own voice. Anyone is welcome to submit a letter (see details on how in my earlier post). Current letters include official national bodies, companies from all over the world, individual accountants, accounting students, and a few random people seemingly just speaking for themselves. We'll submit a letter in the next couple of weeks.
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