The FASB and the IASB Boards (“the Boards”) met at the end of last month to discuss the status of the 2010 Exposure Draft (“the Exposure Draft”) on changes to lease accounting. The majority of the discussion centered on the lessee accounting issue. As has been the case in past meetings, the Boards again reaffirmed their commitment to institute an accounting model requiring that the vast majority of lease liabilities be recognized on the balance sheet. The focus of the discussion in this meeting was on the manner in which lease related expense is recognized and the concerns raised by a number of constituents regarding the accelerated expense recognition pattern which is contained in the Exposure Draft. Unfortunately the Boards did reach any final conclusions and requested that staff engage in further industry outreach. However, there was some consensus that constituent concerns should be addressed and certain alternatives were discussed.
One approach discussed would reintroduce the concept of operating versus finance type leases into the analysis. For those leases that have operating lease attributes, a new type of amortization model would be utilized that would result in a smoother expense recognition pattern and might approximate a straight-line amortization, depending upon variables such as free rent periods and step rents. For those leases that have finance type lease attributes, the amortization method contained in the Exposure Draft would be utilized.
A second approach discussed would introduce another new amortization model which would consider the consumption of the underlying asset during the term of the lease. This method would depend heavily on the fair value of the underlying asset and the estimated decrease in value of the asset during the term of the lease. In those situations where the fair value of the leased asset did not decrease or deceased slightly, the amortization expense would be higher in later periods and therefore the total lease expense would be smoother. This could be the case for many real estate leases. In those situations where the fair value of the leased asset decreased significantly, the amortization expense would be more straight-line resulting in an accelerated expense pattern. This could be the case for many equipment leases.
In attempting to address constituent concerns regarding expense recognition, the Boards have suggested approaches which, in essence, would add complexity, subjectivity and additional cost to the amortization calculations. In some instances, such as fair value estimates, lessees simply would not have the information available to them to make the required calculations. We believe that the feedback that the staff will receive to these approaches will not be positive. The Boards are scheduled to address the issues again in their April meetings and we strongly suggest that interested parties monitor future developments. It seems clear that a revised exposure draft will not be issued until the third quarter of this year.
In a related development, a survey was recently issued by CFO Publishing LLC which gathered responses from 179 senior executives on their plans for dealing with the proposed changes in lease accounting. The responses are consistent with previous posts that we have entered on our Blog. Concerns were expressed regarding the impact on key financial ratios, costs associated with complying with the new accounting standard and business issues related to lease terms and lease versus buy decisions. Two additional key points were made. First, up to 65% of the respondents expect that moderate or substantial changes will have to be made to financial and operating IT systems. And second, only 10% of the respondents believe that they are adequately prepared for the changes at this point. Although there are still issues to be addressed before finalization of the new standard as indicated above, it is critical that companies begin now to prepare for the new standard by making a comprehensive inventory of all leases and capturing critical lease data in a manner that will facilitate review of this information and completion of the required calculations. For the vast majority of companies, this is not the type of analysis that can be completed and maintained on a spreadsheet. Begin now to assess your particular situation and the system enhancements that will be necessary to address the business and financial issues that will inevitably arise.