At its board meeting yesterday, the Financial Accounting Standards Board discussed its joint project on leasing - a project it is conducting jointly with the International Accounting Standards Board. The IASB was slated to discuss the issue today, as the two boards strive to reach a consensus in remaining areas in preparation for publishing a Discussion Paper (DP) on leasing.
The joint project on leasing is one of the major convergence projects on FASB-IASB's Memorandum of Understanding (MOU). The MOU, dating back to the "Norwalk Agreement" in 2002, and updated several times since then (most recently, in Sept. 2008), outlines the plan of the two boards to achieve (on major projects, by 2011), "Convergence of accounting standards ... through the development of high quality, common standards over time."
According to the board’s technical plan, the DP on leasing is slated to be released for public comment 1Q09. Based on information contained in yesterday’s FASB board handout, the staff was prepared to recommend a 120 day comment period for the DP. However, the board did not formally address the comment period issue and was not formally requested to authorize the ballot draft yet, since they asked the staff to come back with further analysis of one issue: subleasing.
Although the current project is scoped to lessee accounting, FASB board members suggested doing a 'sense check' in terms of potential issues of symmetry in lessor accounting, including considering the board's views on insubstance purchase (sale) of assets vs. right of use. Additionally, board members suggested doing a 'sense check' of their views in the leasing project vis-a-vis the separate project on revenue recognition, and that consideration of these issues at this time (prior to issuing the DP) may be a useful approach.
A couple of the 14 issues taken up by FASB yesterday on leasing were deliberated for about an hour each; we have included highlights from one of those issues (measurement) below. For further details see this FEI summary, and for the official results look for the Summary of Board Decisions which FASB generally posts within a day of its board meetings, in FASB’s News Center. (Given the back-to-back FASB and IASB board meetings on leasing, I wonder if perhaps some kind of joint summary of board decisions will be published.)
Measurement of leases, including contingent rents
FASB board members spent over an hour discussing the issue of measurement of leases, including contingent rents. The three alternatives considered were: (1) probability weighting or expected outcome (preferred by the IASB board in an earlier vote), (2) best estimate, and (3) most likely amount (e.g. of rents to pay).
A great deal of the discussion revolved around a debate between whether the ‘best estimate’ could be skewed if someone presumed the most likely outcome was the minimum lease payments, and depending on how contingent lease payments such as performance based payments were estimated or probability weighted (e.g. contingent lease payments based on hitting certain sales targets)
The IASB is understood to be leaning toward a probability weighted or ‘expected outcome’ approach. FASB Chairman Robert Herz noted a probability weighted approach could be more complex than a best estimate approach.
FASB board and staff members asked the IASB project directors who participated in the meeting by phone to explain how, in practice, they believed a probability weighted approach would be performed. IASB project manager Rachel Knubley gave as an example, “We would say, if there is a 10% probability sales of 100, 50% probability of sales of 200 and 40% probability of sales of 300; take the probability weighted average of those three outcomes.”
IASB project manager Simon Peerless added, “In many cases, that will be best you can do, where you have more detailed forecasts, you should be required to use those, rather than just 3 points.”
FASB board member Larry Smith said, “If you ask [IASB board member Jim] Leisenring whether that would represent a probability assessment, he would say no.” The implication was that some may view probability weighted assessments as requiring a more complex, statistically based mathematical approach.
A FASB staff member asked the IASB staff: “In practice, do they do all those probabilities and show auditors those workpapers?”
IASB’s Knubley replied, “It depends, if you have warranties, you would be expected to present good [details], vs. … back of the envelope; lessees may have just one lease; [some may say] all we’re doing is a back of the envelope calculation.”
Herz responded to the IASB staff’s explanation that a back of the envelope calculation may be viewed as fulfilling a probability weighting requirement: “That is OK in a lot of jurisdictions, but if you use those words [probability weighted] in our jurisdiction, it will force people to come up with things they don’t believe in, just to satisfy auditors.” He added, “We would not preclude somebody [from using probability weighting to determine best estimate], but we don’t want to use words that make people do things they don’t do.”
Additionally, Herz observed, “One of the unfortunate problems, realities in the world, seems to be [that using] the same words would be nice, but the same words are not going to produce the same practice, we found … [we’re] not knocking the IASB, [but there is the] issue of auditing, enforcement, all that in other parts of the world” which have to be reckoned with.
FASB board member Larry Smith explained further the potential ramifications of requiring a probability weighted approach in the U.S., saying: “We are trying to avoid making people prepare excel spreadsheets up the wazoo, which they aren’t doing, and across the Atlantic, if they don’t require people to do those workpapers, and if they deem a back of the envelope estimate to be a probability outcome….”
Linsmeier added, “They [the IASB] have to understand it’s an application issue, and a witchhunt on looking for twenty different views [in a probability weighting].”
The IASB board will be presented with the same questions on November 20 which the FASB voted on November 19. Knubley suggested alternative views be provided in the DP.
Smith added, “We had an objective to minimize differences, if we don’t eliminate them all, but eliminate some, we’ve accomplished something.”
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