Friday, May 27, 2011

Preparers Concerned About Change In Direction In FASB, IASB Leasing Proposal

Given the pervasiveness of leasing as a business practice and the potential impact of changes in lease accounting rules, FEI’s Committee on Corporate Reporting (CCR) has been following this project with great interest. Last week, several members tuned in to the webcast of the FASB-IASB joint board meeting and shared their views with me on the latest developments. In the view of those members, the changes voted on by the boards erased the substantial progress that had been made in redeliberations and made the standard more difficult and expensive to implement. [NOTE: Let me remind you of the disclaimer posted in the right margin of this blog; the disclaimer applies to my comments as well as those of the FEI members noted herein.] In brief, according to these members, the Boards decided to:


  1. Require front-end loaded expense recognition for all leases

  2. Eliminate special accommodations for short-term leases

  3. Reinstitute a complex approach to determining lease term
Refer to FASB’s official Summary of Board Decisions for full results of the meeting.

The decisions reached at last week’s FASB-IASB board meeting on leasing are in direct conflict with what CCR recommended in its comment letter on the Leasing Exposure Draft.

Additional insight on decisions reached in the discussion of the leasing project at last week’s joint board meeting can be viewed on the archived webcast of the meeting, which will be posted here.

According to one CCR member, “What is so disappointing about these developments is that they have occurred after unprecedented outreach and consultation, which served to clarify what investors say they want from a new leasing standard. The Boards appeared to listen and had made changes that were directly responsive to what they heard. Now, with time running out, much of this progress has been undone.” Details follow.

Pattern of Expense Recognition
According to the CCR members following the leasing project, last Tuesday the FASB voted 6-1 to keep it simple and force the expense recognition pattern for leases to equal the rental cost recorded under lease accounting today while a majority of the IASB wanted to revert to the much-criticized ED principle that front-end loads expense.

By Thursday, the IASB view had prevailed. The IASB was not in favor of an approach to depreciation of the asset that was other than straight line (e.g., some had suggested a sinking-fund approach that would effectively offset the accretion of the liability using the interest method). The consequence of the IASB’s decision, in the view of these CCR members, is that the expense of the lease is overstated in the early years and understated in the later years. During outreach, as observed by the CCR members, investors were emphatic that this approach was not helpful to them. John Smith, an IASB member from the US (formerly a partner with Deloitte and Touche), had noted that investors will simply have to make adjustments to the reported amounts if they don’t like front-end loading. This raises the question of whether the changes arising from this project will make the accounting more useful or understandable for users.

According to the CCR members, this decision raises complications in a number of important areas, including making it very difficult to deal with large numbers of small dollar leases through materiality. They point out that companies are going to need to compute the expense under both old GAAP and new GAAP in order to make the case that it is immaterial. Having to go through the trouble of doing so could compel many companies, say the CCR member, to decide to make the systems changes to actually book them that way, which could mean incurring hundreds of millions of dollars in IT costs – all to produce financial results that analysts are going to adjust back to eliminate the front-end loading.

Eliminate the accommodation for short term leases

For those leases with a maximum term of 12 months or less, the ED proposed that they be recorded on balance sheet, but granted preparers “relief” by not requiring them to discount recorded amounts.

In redeliberations, the Boards had tentatively decided to ease the burden further by allowing short term leases to be accounted for just like operating leases are today.

However, last week the Boards signaled that they plan to eliminate any relief for short term leases.

Defining the lease term
The ED would have lessees recognize lease assets and liabilities on the basis of the longest possible lease term that was “more likely than not” to occur. During outreach, note the CCR members, this approach was widely criticized by preparers and users.

During redeliberations, the Boards voted to further simplify by moving the definition of lease term to the definition used today. Last Thursday, the Boards decided to reverse course and factor lessee intent into the decision. As a result, lessees and lessors will need to consider contract, asset and other entity specific factors when determining the lease term at inception and each time that term is reassessed. The CCR members observe that this will be very challenging for preparers at do for each individual lease.

CCR members tuning into the most recent deliberations on the leasing project also raised questions about the process. After significant efforts to gather constituent feedback, the Boards, in the view of CCR members following the leasing project, appear to be backing away from acting on what they heard. In particular, these members believe, the desire to finish the leasing project seems to be more important than improving the principles of the final standard.

Warren McGregor, an IASB Board member (and a career standard setter), made it clear that anything other than the ED’s approach on expense recognition would require re-exposure of the proposal and delay issuing the final standard. Accordingly, CCR members following this project believe, the more likely path the Boards will follow will be to post the revised conclusions to the Leasing proposal in the form of a Staff Draft on their websites for informal review.

The CCR members note that the posting of a Staff Draft is not the same level of due process as posting a formal Exposure Draft for public comment. The process, they explain, would be much like so-called “fatal flaw” drafts, in which a principle will only be reconsidered if there is something obviously (and fatally) wrong with it. Therefore, they note, if a company responds to the ‘staff draft’ by reiterating the concerns they expressed in their response (comment letter) to the earlier Exposure Draft, the response they will likely get is the following: the Boards carefully considered these arguments in their due process deliberations, and the company has not identified any new information that would cause the Boards to change their minds.

As previously reported, FEI President and CEO Marie Hollein had written to both Boards last month, applauding the boards decision to take the time necessary on the remaining major convergence projects, and asking that the boards formally publicize and seek comment on the revised conclusions under these projects by formally re-exposing them for public comment, each with at least a 90-day comment period. (See FEI April 19, 2011 comment letter to FASB, IASB.) The above discussion on leasing, note the CCR members following this project, underscores the importance of the recommendation made in Hollein's letter.

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