FASB, IASB May Give Operating Leases New Lease on Life

[NOTE: This post was updated 4/11/11 - see also new blog post, dated 4/11/11, on leasing.] At a joint board meeting last week, FASB and the IASB tentatively agreed to give operating leases a new lease on life, and to modify a provision regarding lease renewal options, as the boards move to finalize their proposed standard on lease accounting. As background, according to results of a Deloitte survey published last week (Deloitte Survey: Only Seven Percent of Companies Are Well Prepared To Comply With New Lease Accounting Standard):

From a financial perspective, more than 80 percent of respondents believe that the lease accounting standards will place a significant burden on financial reporting for tenants as well as property owners. More than 40 percent of respondents believe the new standards would make it more difficult to obtain financing. In addition, 68 percent of respondents said it would have a material impact on their debt to equity ratio; and, roughly 40 percent thought the new lease standard would lead to shorter term leases. Only 35 percent of respondents are extremely or very confident in the integrity of their company's lease data needed to comply with the new standard. Further, to accommodate the new standard, major IT investments would likely be needed. One-quarter of respondents said their companies are likely to have to make a major upgrade to their information technology systems, while 20 percent said they are likely to acquire a new system. Among companies with 1,000 or more leases, the need for IT investment was even greater — 39 percent of these respondents expect the new standards will lead to a major technology system upgrade, while 27 percent expect to acquire a new system. In addition, just 21 percent of respondents are extremely or very confident in the capability of their companies' information technology provider to comply. Half the respondents at companies with 1,000 leases or more expect that implementation would take one year or longer.

Regarding potentially modifying the treatment of leases set forth in the boards' August 2010 Leasing Exposure Draft, according to the minutes of the FASB/IASB joint board meeting:

The Boards tentatively decided to identify a principle for identifying two types of leases for both lessees and lessors, with different profit and loss effects, as follows: 1. A finance lease with a profit or loss recognition pattern consistent with the proposals in the Exposure Draft 2. An other-than-finance lease with a profit or loss recognition pattern consistent with an operating lease under existing IFRSs/U.S. GAAP. (FASB: unanimous; IASB: unanimous) The Boards tentatively decided to establish indicators to distinguish a finance lease from an other-than-finance lease (FASB: unanimous; IASB: unanimous). The Boards asked the staff to use these tentative decisions to perform targeted outreach to determine if stakeholders’ concerns about the profit and loss recognition pattern proposed in the Exposure Draft would be addressed.

As noted by Compliance Week's Tammy Whitehouse, in FASB Retreats Again, This Time on Leasing: [4.11.11 NOTE: Whitehouse's article was updated after initial publication, the original version said that the FASB's Feb. 17 decision was "different from the boards' original proposal that all leases would give rise to an asset and a liability appearing on corporate balance sheets." The updated article now says:

The boards have agreed to consider a structure where “finance leases” would be treated like an installment purchase, putting an asset on the balance sheet as well as a liability to be paid down over time. “Other-than-finance” leases would also appear on the balance sheet, but would flow through the income statement like today's operating leases because the financing element would not be considered significant. That's different from the boards' original proposal that would establish a single accounting method for all leases. The boards have asked their staff to establish indicators that would be used to identify the difference between the two types of leases and do some outreach to see if that would quell the criticism of the original proposal.

My two cents (I remind you of the disclaimer on the right side of this blog): I am a little surprised to see the label of 'other-than-financing' chosen for leases that, under this modified proposal, would be, well, I grant you, 'other-than-financing.' The label may seem self-explanatory to some, but given the history of another recent 'other-than' ... standard (other-than-temporary-impairment, or OTTI, as in declines in market value, see, e.g. prior posts here, here, here, here, here, here, here, here and here), the 'other-than' category may have seemed self-explanatory at the time, and FASB and the IASB have stated they will seek to identify 'indicators' for the financing vs. 'other-than-financing' (OTF?) category, but the contentiousness of the OTTI experience as exacerbated during the credit crisis is still fresh in some minds. A world of difference between OTF and OTTI, maybe just a deja vu thing. 'More Likely Than Not' Would Change to 'Reasonably Assured' Reflecting another tentative decision at the FASB/IASB boards' February 17 joint meeting: the 'more likely than not' trigger related to accounting for renewal options, criticized in comment letters as too vague and/or too low of a bar, would change to 'reasonably assured.' As pointed out by Bob Cook in his Corporate Real Estate Strategy Blog, in a post entitled Lease Accounting Update: More Likely Than Not is No More:

FASB/IASB have dropped one of the most controversial parts of their proposed lease accounting. The Exposure Draft, released in August 2010, had called for lessees with options-to-renew to capitalize lease obligations for renewal periods that were “more likely than not” to occur. This part of the accounting was attacked on many grounds... Before “the people” start celebrating, though, they should understand that there will still be a need to evaluate each and every lease, with an option to renew, to determine whether there is an economic incentive in that option such that renewal of the lease is “reasonably assured” … in which case the renewal period would have to be capitalized … just as is the case under present accounting for capital (or financing) leases. This test will be much less onerous, though. FASB/IASB are going to work on the exact wording, but this “reasonably assured” test has a much higher bar than would have the “more likely than not test” … akin to the difference between 99% and 51%. Few leases will go over the bar and most won’t even come near it so assumption-making will be much easier, and easier to justify to auditors, than it would have been with “more likely than not”.

According to FASB's Technical Plan, a final standard on Leasing is to be issued 2Q11. Read more about the Leasing project and other projects discussed at the FASB/IASB joint board meeting in Summaries of Board Decisions posted in FASB's News Center.

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