Accounting for Leases
In August 2010, the IASB and the FASB jointly issued a draft standard on the accounting treatment of leases that intended to replace the current literature on leases under U.S. GAAP and IFRS.March 3, 2011
by Remi Forgeas, CPA
The main feature of this exposure draft is the recognition of all leases in the statement of financial position of the lessee, without distinguishing between operating and financial leases. For lessor accounting, a hybrid model based on the economic characteristics of the contract was proposed, leading to the application of either the partial-derecognition approach or the performance-obligation approach.
A lot of responses were received (about 800 comments letters). The International Accounting Standards Board (IASB) staff has just published a summary (PDF) of the comments received in letters and during the round tables and workshops organised during the second half of 2010.Comments on Accounting Models
There was broad support for the boards' efforts in developing a single, comprehensive and converged model for lease accounting. The proposed model consists of the recognition of a right of use and a financial liability. Beyond this basic principle, criticisms are numerous and relate to:
Comments are almost unanimous in censuring the proposed hybrid model. Many judge this model to be less comprehensive than the one developed for lessees. Many commentators suggest that substantial work should be undertaken by the two boards before any amendments to lessor accounting can be made.
The responses express doubts that the draft generates improvements compared to the current standard. Moreover, many consider the current lessor accounting model works just fine. In addition, many emphasized the complexity of the hybrid model and the unfavorable cost/benefit ratio that would result from implementing such a model.
The views of stakeholders differ, however, as to whether the lessee accounting should be finalized first before addressing the lessor accounting or to cover both models in a single project while accepting further delay in the adoption of the standard.Comments on Key Features
A majority of commentators considers the definition of a lease as proposed in the draft is not narrow enough. Another complaint is that this definition makes the assessment whether a contract should be accounted for as a lease or as a service sometime impossible.
The general view is that with an appropriate definition of a lease contract and an appropriate definition of a sale (in the Revenue From Contracts With Customers exposure draft), no additional guidance on distinguishing a lease from a purchase/sale contract would be needed.Lease term
There is a clear consensus among the respondents: almost everyone disagreed with the definition of the lease term as the longest possible term, that is more likely than not, to occur.
The main alternatives proposed were:
Many respondents disagreed with the proposal to estimate-lease payments, term-option penalties and residual-value guarantees using an expected outcome technique.
The general view is that estimating variable lease payments would be costly. Doubts exist on the reliability of these estimates. In the absence of a reliable measurement of lease/liabilities, unjustified volatility would be reflected in profit or loss.
Nor was there unanimous support for taking account of all contingent-lease payments.Short-term leases
Responses welcomed the introduction of a simplified treatment for short-term leases. However, many proposed that this simplified approach should be consistent with current operating lease accounting for both lessors and lessees (the exposure draft requires lessees to continue to recognize a lease asset and a lease liability in their statement of financial position).
Overall responses to the single model proposed for lessee accounting are fairly favorable. However, critics focused on the reliance on estimates and judgements, especially on the following:
On the flip side, the hybrid model of lessor accounting was heavily criticized and the staff has been asked to conduct a thorough re-examination of this model.
The definition of a lease also provoked calls for clarification, in particular in order to differentiate lease contracts from in-substance sale.
Given the short deadline (June 30, 2011 is the expected issuance date) and the extent of the outstanding work, commentators have strongly recommended that the staff should focus on drafting a standard based on sound principles, even if this implies additional delay in the issuance date of the standard.What Should Be the IASB/FASB Action Plan for the Coming Months?
The two boards have published a working document presenting a proposed timetable for their re-deliberations. They have identified five main themes to be addressed:
The nature of the subjects debated by the Boards in January illustrates the complexity of the topics and the fact that major topics may have to be revisited, which will take some time.
However, the IASB and the Financial Accounting Standards Board (FASB) reiterated that the current timetable is unchanged and the standard is still expected in June 2011.
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Remi Forgeas, CPA, is an audit and assurance partner for Mazars US and provides his views on international convergence of GAAP and whether progress is really being made in light of recent developments. For U.K. IFRS, you can contact, Steven Brice who is a technical partner in the financial reporting advisory group for Mazars UK and provides his views on international convergence of GAAP and whether progress is really being made in light of recent developments
* The views expressed in this article are the author’s own and do not necessarily reflect the views of the AICPA or AICPA Corporate Finance Insider.