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.
Wednesday, October 21, 2015
Wednesday, March 18, 2015
IASB: It's a wrap
At the IASB's March 17, 2015, meeting, the board unanimously agreed that it is done with the new lease accounting standard, and committed their work to the drafting process. They considered whether or not another exposure draft was necessary, and concluded it was not, because all the substantive changes from the 2013 exposure draft either a) have been previously exposed (the single lease model was proposed in the 2010 exposure draft), b) are changes to retain existing accounting (lessor accounting), or c) are simplifications or clarifications responding to feedback received (such as excluding "small assets").
One IASB member stated an intention to dissent from the new standard. Presumably the others are on board.
The FASB is at essentially the same position. Neither board has stated a timeline more specific than "later in 2015" for when the final standard will be fully drafted and voted on. Neither have they set an effective date, though generally discussion has suggested two full years to prepare, which would suggest a January 1, 2018, effective date.
The IASB has released a summary document, Leases: Practical implications of the new Leases Standard, which describes the most important characteristics of the upcoming standard, with a comparison between current accounting and the two different standards that the IASB and FASB will be releasing.
It's been a slow train coming. The project was announced in July 2006. Maybe it'll be done for its ninth birthday, maybe not.
One IASB member stated an intention to dissent from the new standard. Presumably the others are on board.
The FASB is at essentially the same position. Neither board has stated a timeline more specific than "later in 2015" for when the final standard will be fully drafted and voted on. Neither have they set an effective date, though generally discussion has suggested two full years to prepare, which would suggest a January 1, 2018, effective date.
The IASB has released a summary document, Leases: Practical implications of the new Leases Standard, which describes the most important characteristics of the upcoming standard, with a comparison between current accounting and the two different standards that the IASB and FASB will be releasing.
It's been a slow train coming. The project was announced in July 2006. Maybe it'll be done for its ninth birthday, maybe not.
Friday, January 9, 2015
Standard release schedule update
The IASB has updated their project schedule with a target date for release of the new lease accounting standard: sometime in the second half of 2015. (The FASB's Current Technical Plan page has had a gee-whiz makeover that looks snazzy but provides no useful information about dates.)
At the December joint board meeting, the boards decided not to include in the definition of a lease that the lessee "must have the ability to derive the benefits from directing the use of an identified asset." So the definition remains “a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration,” with the requirement that the asset be implicitly or explicitly identified (rather than simply the use of one of an ever-changing pool of assets, which is considered a service contract rather than a lease).
No board deliberations on leases are scheduled for this month.
At the December joint board meeting, the boards decided not to include in the definition of a lease that the lessee "must have the ability to derive the benefits from directing the use of an identified asset." So the definition remains “a contract that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration,” with the requirement that the asset be implicitly or explicitly identified (rather than simply the use of one of an ever-changing pool of assets, which is considered a service contract rather than a lease).
No board deliberations on leases are scheduled for this month.
Tuesday, November 18, 2014
Misinformed congressmen in WSJ
In the Nov. 10, 2014, issue of the Wall Street Journal, congressmen Brad Sherman and Peter King attacked the planned new lease accounting standard, claiming that it will "fabricate trillions in new debt" and thereby crush the economy. They reference a study that foresees a loss of at least 190,000 U.S. jobs, and $27.5 billion in economic activity (up to a worst-case scenario of 3.3 million lost jobs and $400 billion in lost GDP!). All for an accounting change?
There are several problems with this attack. The most significant is that the study forecasts the effect of a standard that is no longer being proposed. The study was written in early 2012, when the proposal was to treat all leases as capital, including all optional renewal periods deemed "more likely than not" to be exercised. This proposal was eventually recognized as onerous by the boards, and substantially scaled back. While the IASB has retained the plan to treat all leases as capital with a one-size-fits-all calculation process, it eliminated including options unless exercise is "reasonably certain." The FASB has made the same adjustment to options, has chosen to keep a separate accounting model for operating leases, and is now saying that the liability to be shown on the balance sheet should be considered a "non-debt liability," meaning it will not affect debt covenants in loans, bonds, and the like.
The op-ed contains other inaccuracies. It suggests that under the new proposal, businesses would be burdened with "constantly tracking and remeasuring the 'fair value' of leases of every kind, from a business's office space to the photocopier down the hall." This is ridiculous, and was never part of any proposal coming from the boards. A fundamental concept of lease accounting is that fair value is not remeasured during the life of the lease, except by algorithm; the fair value is assumed to be the amortized net asset value, unless a material impairment needs to be recognized. This is true under FAS 13, and has not changed in the slightest as part of the new proposals. The op-ed also talks about accelerating expense recognition; that will happen to companies covered by international IFRS rules, but not under the current FASB proposal.
The op-ed notes that Congressman Sherman is an accountant. But obviously he doesn't have enough time to keep up on what's really happening in accounting. He should be embarrassed to have put his name on a column that misstates accounting principles and proposals so badly. (So should Rep. King, though he doesn't claim an accountant's credentials.) They darkly warn that Congress will have to act to rein in the FASB if the SEC doesn't. One hopes that they'll learn the actual facts before they try to politicize accounting standards.
The Nov. 17 issue of the Journal includes several letters to the editor, most of which point out the value of capitalizing lease obligations, and noting that banks often require doing this pro forma already. The new proposal, they argue, will simply reflect economic reality. I'm surprised that none of them note that Sherman and King are attacking a straw man.
There are several problems with this attack. The most significant is that the study forecasts the effect of a standard that is no longer being proposed. The study was written in early 2012, when the proposal was to treat all leases as capital, including all optional renewal periods deemed "more likely than not" to be exercised. This proposal was eventually recognized as onerous by the boards, and substantially scaled back. While the IASB has retained the plan to treat all leases as capital with a one-size-fits-all calculation process, it eliminated including options unless exercise is "reasonably certain." The FASB has made the same adjustment to options, has chosen to keep a separate accounting model for operating leases, and is now saying that the liability to be shown on the balance sheet should be considered a "non-debt liability," meaning it will not affect debt covenants in loans, bonds, and the like.
The op-ed contains other inaccuracies. It suggests that under the new proposal, businesses would be burdened with "constantly tracking and remeasuring the 'fair value' of leases of every kind, from a business's office space to the photocopier down the hall." This is ridiculous, and was never part of any proposal coming from the boards. A fundamental concept of lease accounting is that fair value is not remeasured during the life of the lease, except by algorithm; the fair value is assumed to be the amortized net asset value, unless a material impairment needs to be recognized. This is true under FAS 13, and has not changed in the slightest as part of the new proposals. The op-ed also talks about accelerating expense recognition; that will happen to companies covered by international IFRS rules, but not under the current FASB proposal.
The op-ed notes that Congressman Sherman is an accountant. But obviously he doesn't have enough time to keep up on what's really happening in accounting. He should be embarrassed to have put his name on a column that misstates accounting principles and proposals so badly. (So should Rep. King, though he doesn't claim an accountant's credentials.) They darkly warn that Congress will have to act to rein in the FASB if the SEC doesn't. One hopes that they'll learn the actual facts before they try to politicize accounting standards.
The Nov. 17 issue of the Journal includes several letters to the editor, most of which point out the value of capitalizing lease obligations, and noting that banks often require doing this pro forma already. The new proposal, they argue, will simply reflect economic reality. I'm surprised that none of them note that Sherman and King are attacking a straw man.
Friday, August 8, 2014
July meeting update, project update
The joint IASB/FASB meeting of July 22-24, 2014, included leases on its agenda (on July 23). There were two main topics of conversation: sale/leaseback transactions and lessor disclosure requirements. The IASB summary is available online, with more discussion detail provided by Deloitte's IASPlus.
The FASB decided, however, that if the leaseback meets "type A" criteria (i.e., it's a capital lease), the transaction would not be considered a sale. In other words, if the risks and rewards of ownership are being transferred back to the seller-lessee, no sale really happened.
The IASB concluded that a "substantive repurchase option" precludes sale recognition while the FASB will explore further the effect of repurchase options at fair value.
The buyer-lessor accounts for the purchase like that of any other nonfinancial asset.(ignoring the leaseback).
The seller-lessee accounts for any loss on sale like that of any other sale.
Both parties treat the lease like any other lease.
For the gain, the two boards split: the FASB concluded that the full gain should be recognized just as with any other sale. The IASB held that only the portion of the gain applicable to the residual asset can be recognized at sale.
If the official sale price is higher or lower than the market price ("off-market"), a reduced sale price is treated as a prepayment of rent; a higher sale price is treated as additional financing by the buyer-lessor to the seller-lessee.
In the case of a "failed" transaction (i.e., a transaction that cannot be considered a sale/leaseback), the IASB voted to treat it as a financing transaction. The FASB voted to study the situation further.
A lessor must provide a table of lease income, comprising:
Separate maturity analysis tables are required for Type A and Type B leases, showing the amount of (undiscounted) lease payments by year for the next five years, then all remaining years. Type A leases need a further reconciliation to the receivable balance, as is done in current accounting, as well as an explanation of significant changes in net investment during the reporting period, with the FASB reserving the possibility of adjustments to this requirement based on the concurrently running project on impairments.
The update restates the boards' insistence that improving disclosure alone is insufficient, that it is vital to have lease contract commitments on the balance sheet. It provides an example of two actual companies, one of which does little leasing while the other gets most of its assets through leasing. With leases off the balance sheet, the heavy lessee looks to be less leveraged; once adjusted for the effect of leasing, the heavy lessee is revealed to be considerably more leveraged. It shows that "rule of thumb" estimates, like multiplying rent expense by 8 to calculate liability, are too inexact. And it emphasizes that even if sophisticated analysts, doing in-depth research on individual companies, can reach reasonable approximations (though lacking all the desirable data), this doesn't serve less sophisticated investors, or those who are looking at large groups of companies, who must rely on the basic financial statements. Thus, while the boards have been willing to consider adjustments to the details, the fundamental concept of putting leases on the balance sheet is fixed.
Sale/leaseback transactions
The boards reaffirmed that for a transaction to be considered a sale/leaseback, the sale must meet the requirements of the new Revenue Recognition joint standard (ASU 2014-09/ASC 606/IFRS 15). However, "continuing involvement" generally precludes sale recognition under that standard, and the boards clarified that an ordinary leaseback does not trigger that clause and preclude sale/leaseback accounting.The FASB decided, however, that if the leaseback meets "type A" criteria (i.e., it's a capital lease), the transaction would not be considered a sale. In other words, if the risks and rewards of ownership are being transferred back to the seller-lessee, no sale really happened.
The IASB concluded that a "substantive repurchase option" precludes sale recognition while the FASB will explore further the effect of repurchase options at fair value.
The buyer-lessor accounts for the purchase like that of any other nonfinancial asset.(ignoring the leaseback).
The seller-lessee accounts for any loss on sale like that of any other sale.
Both parties treat the lease like any other lease.
For the gain, the two boards split: the FASB concluded that the full gain should be recognized just as with any other sale. The IASB held that only the portion of the gain applicable to the residual asset can be recognized at sale.
If the official sale price is higher or lower than the market price ("off-market"), a reduced sale price is treated as a prepayment of rent; a higher sale price is treated as additional financing by the buyer-lessor to the seller-lessee.
In the case of a "failed" transaction (i.e., a transaction that cannot be considered a sale/leaseback), the IASB voted to treat it as a financing transaction. The FASB voted to study the situation further.
Lessor disclosure requirements
A lessor must disclose descriptions of the nature of its leases, assumptions and judgments made in applying the lease accounting standard, and how it manages risks related to residuals.A lessor must provide a table of lease income, comprising:
- For type A leases: profit or loss recognized at lease inception, and interest income
- For type B leases: lease income from lease payments
- Variable lease payments
Separate maturity analysis tables are required for Type A and Type B leases, showing the amount of (undiscounted) lease payments by year for the next five years, then all remaining years. Type A leases need a further reconciliation to the receivable balance, as is done in current accounting, as well as an explanation of significant changes in net investment during the reporting period, with the FASB reserving the possibility of adjustments to this requirement based on the concurrently running project on impairments.
Upcoming
Remaining topics to be discussed in upcoming months include lessee disclosure and transition requirements. They also have said they will consider a possible exclusion of "small ticket" items, to make implementation less onerous.Project update
The IASB released on August 7 an update describing major decisions reached, with an accompanying podcast; it doesn't go into detail on the different decisions reached by the FASB. It notes that the boards expect to complete their deliberations in 2015 (no more specific). This raises the question of whether implementation will get pushed off to 2018.The update restates the boards' insistence that improving disclosure alone is insufficient, that it is vital to have lease contract commitments on the balance sheet. It provides an example of two actual companies, one of which does little leasing while the other gets most of its assets through leasing. With leases off the balance sheet, the heavy lessee looks to be less leveraged; once adjusted for the effect of leasing, the heavy lessee is revealed to be considerably more leveraged. It shows that "rule of thumb" estimates, like multiplying rent expense by 8 to calculate liability, are too inexact. And it emphasizes that even if sophisticated analysts, doing in-depth research on individual companies, can reach reasonable approximations (though lacking all the desirable data), this doesn't serve less sophisticated investors, or those who are looking at large groups of companies, who must rely on the basic financial statements. Thus, while the boards have been willing to consider adjustments to the details, the fundamental concept of putting leases on the balance sheet is fixed.
Wednesday, July 2, 2014
Type B lease accounting
Since it seems highly likely that Type B lease accounting will survive for current lessee operating leases in the U.S. (with perhaps a few leases at the margins moving in and out of such treatment), I thought it might be worthwhile to look in more detail at some examples of how Type B accounting will work. (Let's hope they come up with a nicer name for it; "type A" and "type B" are totally arbitrary, and don't at all describe the accounting involved.)
With simple leases (no initial direct costs, the same rent paid throughout the life of the lease), the calculations are pretty simple: both the asset and liability are, at any given moment, equal to the present value of the remaining rent (excluding service components, of course). But life is rarely simple. So let's look at a few variations on a theme.
Example #1: We'll start with a simple lease of five years, starting 1/1/2014, paid yearly in advance (i.e., first payment due first day of the lease), rent 10,000 per year, and an incremental borrowing rate of 6%. There are no initial direct costs.
The present value of the rents at inception is 44,651.06. Both the initial liability and asset are set to that amount. The balances at the end of each year, and the effective interest calculated (not expensed, but used to determine the drawdown on the balance sheet accounts), are as follows:
As you can see, the liability and asset are identical at all times. The reduction in each is the rent (10,000) less the effective interest (for 2014, 10,000 - 2,079.06 = 7,920.94). The yearly expense is the 10,000 rent.
Example #2: Many leases have changes in rent during the life of the lease. Let's say that for this lease, the rent increases to 11,000 per year starting 1/1/2016 (start of 3rd year).
The yearly expense is 10,600 (the average of the rent over the lease term). Effectively, the difference between the cash and level rent is recognized in the asset, instead of the FAS 13 practice of setting up a deferred rent liability.
Example #3: Going back to the simple lease of 10,000 rent per year. This time we add initial direct costs of 2,000, which is added to the asset but not the liability.
The yearly expense is 10,400 (rent plus a straight-line portion of the initial direct costs).
Example #4: No initial direct costs. Payments are made in arrears (that is, the first payment is made at the end of the first year).
The yearly expense is 10,000 (the yearly rent, same as example #1). You may notice that the effective interest for years 2-5 is identical to the interest for years 1-4 in examples 1 & 3.
With simple leases (no initial direct costs, the same rent paid throughout the life of the lease), the calculations are pretty simple: both the asset and liability are, at any given moment, equal to the present value of the remaining rent (excluding service components, of course). But life is rarely simple. So let's look at a few variations on a theme.
Example #1: We'll start with a simple lease of five years, starting 1/1/2014, paid yearly in advance (i.e., first payment due first day of the lease), rent 10,000 per year, and an incremental borrowing rate of 6%. There are no initial direct costs.
The present value of the rents at inception is 44,651.06. Both the initial liability and asset are set to that amount. The balances at the end of each year, and the effective interest calculated (not expensed, but used to determine the drawdown on the balance sheet accounts), are as follows:
| End Date | Liability | Asset | Effective Interest |
|---|---|---|---|
| Initial | (44,651.06) | 44,651.06 | |
| 12/31/2014 | (36,730.12) | 36,730.12 | 2,079.06 |
| 12/31/2015 | (28,333.93) | 28,333.93 | 1,603.81 |
| 12/31/2016 | (19,433.96) | 19,433.96 | 1,100.04 |
| 12/31/2017 | (10,000.00) | 10,000.00 | 566.04 |
| 12/31/2018 | (0.00) | 0.00 | 0.00 |
As you can see, the liability and asset are identical at all times. The reduction in each is the rent (10,000) less the effective interest (for 2014, 10,000 - 2,079.06 = 7,920.94). The yearly expense is the 10,000 rent.
Example #2: Many leases have changes in rent during the life of the lease. Let's say that for this lease, the rent increases to 11,000 per year starting 1/1/2016 (start of 3rd year).
| End Date | Liability | Asset | Effective Interest |
|---|---|---|---|
| Initial | (47,172.77) | 47,172.77 | |
| 12/31/2014 | (39,403.13) | 38,803.13 | 2,230.37 |
| 12/31/2015 | (31,167.32) | 29,967.32 | 1,764.19 |
| 12/31/2016 | (21,377.36) | 20,577.36 | 1,210.04 |
| 12/31/2017 | (11,000.00) | 10,600.00 | 622.64 |
| 12/31/2018 | (0.00) | 0.00 | 0.00 |
The yearly expense is 10,600 (the average of the rent over the lease term). Effectively, the difference between the cash and level rent is recognized in the asset, instead of the FAS 13 practice of setting up a deferred rent liability.
Example #3: Going back to the simple lease of 10,000 rent per year. This time we add initial direct costs of 2,000, which is added to the asset but not the liability.
| End Date | Liability | Asset | Effective Interest |
|---|---|---|---|
| Initial | (44,651.06) | 46,651.06 | |
| 12/31/2014 | (36,730.12) | 38,330.12 | 2,079.06 |
| 12/31/2015 | (28,333.93) | 29,533.93 | 1,603.81 |
| 12/31/2016 | (19,433.96) | 20,233.96 | 1,100.04 |
| 12/31/2017 | (10,000.00) | 10,400.00 | 566.04 |
| 12/31/2018 | (0.00) | 0.00 | 0.00 |
The yearly expense is 10,400 (rent plus a straight-line portion of the initial direct costs).
Example #4: No initial direct costs. Payments are made in arrears (that is, the first payment is made at the end of the first year).
| End Date | Liability | Asset | Effective Interest |
|---|---|---|---|
| Initial | (42,123.64) | 42,123.64 | |
| 12/31/2014 | (34,651.06) | 34,651.06 | 2,527.42 |
| 12/31/2015 | (26,730.12) | 26,730.12 | 2,079.06 |
| 12/31/2016 | (18,333.93) | 18,333.93 | 1,603.81 |
| 12/31/2017 | (9,433.96) | 9,433.96 | 1,100.04 |
| 12/31/2018 | (0.00) | 0.00 | 566.04 |
The yearly expense is 10,000 (the yearly rent, same as example #1). You may notice that the effective interest for years 2-5 is identical to the interest for years 1-4 in examples 1 & 3.
Tuesday, July 1, 2014
Subleases, balance sheet, cash flow
The FASB/IASB joint meeting for June was held June 17-19, 2014. The boards discussed subleases, lessee balance sheet presentation, and cash flow statement presentation. Discussions were made in the context of the FASB's tentative decision to permit two different types of lessee presentation (Type A leases, essentially the same as current capital leases, and Type B leases, similar to current operating leases but with an asset and liability on the balance sheet) and the IASB's tentative decision to treat all lessee leases as Type A capital leases.
In keeping with this, the assets and liabilities of the two contracts should not be offset (unless them meet financial instruments requirements for offsetting). Likewise, lease income and lease expense should not be offset unless the intermediate lessor meets the "principal-agent" guidance in the newly released revenue recognition standard (ASC 606, IFRS 15).
The FASB held that a sublease should be classified with reference to the underlying asset, while the IASB calls for classifying it with reference to the right-of-use (ROU) asset arising from the head lease.
Since the IASB has decided to have a single lessee accounting model, while maintaining the existing capital vs. operating separation for lessors, subleases will end up with accounting that is not in sync between the two sides of the transaction.
Likewise, liabilities can be reported as a separate line item or disclosed in the footnotes, with Type A and Type B liabilities reported separately. If liabilities are combined in the primary statement, the footnote should indicate which line item contains the lease liabilities.
Lessees: Confirming the RED, cash payments for the principal portion of a Type A lease are financing; cash payments for the interest portion of a Type A lease are operating (FASB), or either operating or financing based on a lessee's accounting policy choice (IASB); cash payments for a Type B lease are operating.
The IASB also decided to require a separate presentation of total lease payments, so that statement users can find a single number for the cash outflow.
Subleases
Both boards agreed that the intermediate lessor (who leases the underlying asset from its owner, and subleases it out to the sublessee) should account for the head lease and the sublease as two separate contracts, unless the contracts meet contract combinations guidance that the boards adopted in April. (This guidance indicated that they should be combined "if either of the following criteria are met: (a) The contracts are negotiated as a package with a single commercial objective; or (b) The amount of consideration to be paid in one contract depends on the price or performance of the other contract.")In keeping with this, the assets and liabilities of the two contracts should not be offset (unless them meet financial instruments requirements for offsetting). Likewise, lease income and lease expense should not be offset unless the intermediate lessor meets the "principal-agent" guidance in the newly released revenue recognition standard (ASC 606, IFRS 15).
The FASB held that a sublease should be classified with reference to the underlying asset, while the IASB calls for classifying it with reference to the right-of-use (ROU) asset arising from the head lease.
Since the IASB has decided to have a single lessee accounting model, while maintaining the existing capital vs. operating separation for lessors, subleases will end up with accounting that is not in sync between the two sides of the transaction.
Balance sheet presentation
Both boards agreed that Type A lessee lease assets should either be presented as a separate line item, or combined with the same type of assets as the underlying leased assets and then disclosed separately in the notes (the latter treatment is not permitted if the amounts are material). The FASB concluded that Type B assets should be treated likewise, and should be separated from Type A assets. This will facilitate analysis that depends on distinguishing lease types, such as bankruptcy analysis, bank regulatory capital tests, and possibly loan covenants.Likewise, liabilities can be reported as a separate line item or disclosed in the footnotes, with Type A and Type B liabilities reported separately. If liabilities are combined in the primary statement, the footnote should indicate which line item contains the lease liabilities.
Cash flow presentation
Lessors: Confirming the 2013 Revised Exposure Draft (RED), lease cash receipts are classified within operating activities.Lessees: Confirming the RED, cash payments for the principal portion of a Type A lease are financing; cash payments for the interest portion of a Type A lease are operating (FASB), or either operating or financing based on a lessee's accounting policy choice (IASB); cash payments for a Type B lease are operating.
The IASB also decided to require a separate presentation of total lease payments, so that statement users can find a single number for the cash outflow.
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