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Grant Thornton Warns FASB Leasing Proposals Could Lead to Structuring

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September 18, 2013

Grant Thornton is one of the many firms and organizations weighing in on the lease accounting changes proposed by the Financial Accounting Standards Board and the International Accounting Standards Board, which would add leases to corporate balance sheets around the world for the first time.

The new rules would require businesses to account for leased property and equipment as though they owned it, affecting everything from copy machines to office buildings, and potentially doubling the size of many corporate balance sheets as leased items are recorded as assets and liabilities.

The lease proposals could also change the calculation of metrics such as leverage, capital expenditures, EBITDA, and interest coverage, according to the firm, which could affect contractual arrangements such as debt covenants, purchase agreements, compensation arrangements and other contracts that refer to financial information. Real estate and transportation, in particular, would be some of the major sectors affected by the lease accounting changes.

John Hepp

“Although we fully support the boards’ goal to improve lease accounting, we are not in favor of proceeding with finalization of the [exposure draft] in its current form at this time,” Grant Thornton International global leader of assurance services Kenneth C. Sharp and Grant Thornton LLP managing partner of professional standards Jeffrey L. Burgess wrote in a comment letter. “Although we appreciate the efforts that the boards have expended in undertaking to address the issues raised with the 2010 Exposure Draft Leases (2010 ED), we believe the latest proposals would not improve financial reporting and would require substantial implementation costs.”

John Hepp, a partner in Grant Thornton’s Accounting Principles Consultation Group, explained some of the firm’s concerns during a phone interview Monday.

“We started from whether we thought the proposal would provide better or more useful information for somebody reading the financial statements and then whether that information would provide more benefit than the cost that would be involved in providing it,” he said. “We were having trouble getting to where the information provided under the proposals would be better than what we have today. That was obviously a serious concern of ours because this would be a major change in the accounting model, not just in the accounting for leases.”

Grant Thornton began looking at the causes of the complexity and why the lease accounting information might not be useful. “We looked at when a lessee has an obligation to make payments into the future,” Hepp explained. “The amount of those future cash flows is what’s of interest to the user of the financial statements. One of the features of the ‘right of use’ model is that it takes the amount of those lease payments in many leases, particularly real estate leases, and it would separate out the amounts that are attributable to the right of use for the asset and the amount of use for the other services, or executor amounts. At the end of the day you would go through some complex calculations that would lead to something other than the information that a user would be interested in. They would be interested in the entire amount of the cash flows that are committed in the future, not just a portion of them that are attributable to the right of use asset.”

The firm is concerned the leasing proposals could tempt companies to structure the transactions.  “By making that distinction, you are creating a new very bright-line distinction between what is a lease and what is not a lease and what is a lease element and what is not a lease element, and that opens the door to structuring on a lot of different arrangements,” said Hepp. “That again would lead to the information being less useful to the people that are relying on the information on the financial statements. Then, conceptually looking at the model, we started to realize that there would be a significant difference between how you would account for a transaction, depending on whether it’s a sale or a lease. The economic substance of those transactions is generally very similar. So why would you have one model for revenue recognition for accounting for a sale and a separate model for accounting for a lease? That creates opportunities for structuring because now I can decide whether to account for something as a sale or a lease and get different accounting treatments, both as the lessor or lessee.”

Hepp noted that it can get even more complicated if you have a group of assets involved that could constitute a business. “Then the question could become, ‘Should I be accounting for this as a business combination or as a lease?’ Of course, you would get very different answers there too. We think the issue is actually the right of use asset. The notion that a tangible asset is a bundle of rights that can somehow be separated, with some of them sold and some of them retained by the lessor, and some of them recorded by the lessee and some not, we just think that it doesn’t lead to information that’s comparable, that really provides information on the assets that are deployed and financed by the lessee. It doesn’t provide information on the full future cash flows.”

FASB asked stakeholders in the exposure draft about what they would do as a possible solution. “Our answer was that we would provide a control-based model,” said Hepp. “That’s the model that’s used in both consolidation and revenue recognition. Why would you have a different model for leasing?”

Hepp plans to participate in a meeting at FASB headquarters in Norwalk next Monday to air his views, although it won’t be the first time FASB has heard them. Grant Thornton has published a series of white papers on the subject of lease accounting, including one co-authored by Hepp entitled, “Are All Leases Created Equal?

“These ideas are not new,” he said. “We didn’t just make things up overnight. There was a process over several years of coming to these opinions.”

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