Not everyone is hailing the Financial Accounting Standards Board’s new lease accounting standard, including one FASB member who voted against the standard, and a key investor group that has also expressed qualms.
FASB released the long-awaited leasing standard last week after a decade of work with the International Accounting Standards Board as one of their major convergence projects (see FASB Releases Lease Accounting Standard). Near the end of Section B of the new leasing standard, on page 331, is the summary of a dissent from longtime FASB member Marc Siegel. While the other six board members voted to affirm the standard, FASB acknowledged, “Mr. Siegel dissents from the issuance of the guidance in this Update because, on balance, he believes that the new information will not represent sufficient predictive value, confirmatory value, or both to be decision useful to financial statement users. While Mr. Siegel firmly agrees with the recognition of lease assets and liabilities for all leases, he believes that the measurement of the lessee’s liability required by the guidance will provide insufficient decision-useful information for investors, such that significant adjustments will continue to be made by financial statement users.”
Specifically, Siegel disagreed with the guidance on renewal options and variable lease payments and contended that it is inconsistent with other parts of the Accounting Standards Codification that address customer options and contingent or variable amounts.
“As such, Mr. Siegel has concluded that the guidance fails to meet the objective in this Update of reporting useful information to financial statement users about the amount, timing, and uncertainty of cash flows arising from a lease,” according to the document.
In addition to Siegel’s dissent, the CFA Institute, which represents Chartered Financial Analysts, is also expressing a preference for the alternative approach to measurement that the International Accounting Standards Board adopted in its version for International Financial Reporting Standards.
“We’re not extremely happy with the measurement that was chosen, the optionality of leases and indexes,” said Sandy Peters, head of the Global Financial Reporting Policy Group at CFA Institute. “But we were happy to see that the obligations were recognized. We take a long-term view on these things and say, ‘Let’s get them on the balance sheet and then let’s get everybody to see the measurement and what it means, and have them get some questions on it and see if we can work to improve that over time, just like we did on pensions.’”
She noted that the CFA Institute has long advocated for leases to be recognized as liabilities on the balance sheet. “We’re happy to see that there are liabilities,” she said. “We’re not thrilled with the measurement of the liability. We agree more with the IASB’s amortization approach rather than the FASB’s. They have the amortization and then they have the sort of straight-line approach. There’s a level approach under the FASB model and then there is the sort of right-of-use approach. You’re going to split it up and show what is the amortization of the asset, what’s the interest, all those sorts of things. We like the single approach adopted by the IASB better.”
FASB is aware that not everyone is going to be satisfied with the new standard. “I think the standards have benefited significantly from the constructive feedback that we’ve had from all our constituents, both preparers doing that through associations or directly, as well as investors,” FASB vice chair Jim Kroeker told Accounting Today last week. “As you would expect when you’re making change, not everyone is at the outset as happy with the change as everyone else. We will continue to be available for outreach particularly as it relates to successful implementation.”
Many financial analysts have traditionally used their own estimates of what the lease obligations should be on the balance sheet. The new standard was supposed to help with that, but it may complicate the process even more.
In his dissent, Siegel voiced concern that users might be misled by the measurements and, therefore, will incur costs to make considerable, albeit very different, adjustments to unwind the accounting required by the accounting standards update to accommodate their analysis. Peters agrees and believes analysts will still need to make adjustments.
“Over time, I think what the world will see is that as they talk to the analyst community, and the investor community starts to understand these numbers, what we find is that companies actually want to improve the measurement simply because it’s already there and they want it to be economic because they don’t want to have to keep explaining it,” she said. “We just see this as a first step in the change.”
Kroeker believes the new standard will put investors on a more balanced footing. “Today maybe sophisticated investors are making those calculations,” he said. “But it’s not clear that everyone who is looking at a set of financial statements is even aware that they ought to be thinking about that. I think sophisticated or more educated investors realize there is a missing obligation. They’re making estimates. Some of those estimates we’ve heard are pretty crude, by taking numbers say seven or eight times the operating lease payments, so this will put them on a balanced starting point. Investors, as they do with other aspects in their modeling, want to make adjustments for lease renewals. If [a company is] only committed to a lease property for five years, this will give you more information about lease commitment terms. An investor might want to know the expected cash flows for years beyond that commitment. This will give them a better starting point for modeling. It’s in that way investors are on a balanced and neutral starting point.”