The International Accounting Standards Board has released a new document describing some of its most recent tentative decisions from the first half of the year on the standards for lease accounting, including what appears to be an about-face on how leases should be categorized, opening up a new gulf between it and the Financial Accounting Standards Board.
In the document, the IASB said the two boards have made different tentative decisions regarding the recognition and presentation of lease expenses in a lessee’s income statement. The IASB has tentatively decided to propose a single lessee model that would require the recognition of interest and amortization for all leases recognized on a lessee’s balance sheet. FASB, for its part, has tentatively decided to propose a dual model that retains the existing distinction between finance leases (that is, leases that are in-substance purchases) and operating leases. FASB’s model would result in no change to a lessee’s income statement, but recognizes all leases on the balance sheet.
The IASB explained that the feedback it received on the lessee model has been mixed throughout the project. “Some view all leases as financing transactions,” it said. “Others view almost no leases as financing transactions. For others, the economics are different for different leases.”
Both boards originally proposed a single lessee model in a 2009 discussion paper and a 2010 exposure draft. In response, some of the commenters agreed with that model, while others did not.
In response to requests from some stakeholders to better reflect the economic differences between different leases, the boards proposed a dual model in the 2013 exposure draft. That model distinguished between most real estate leases and other leases, and attempted to identify real economic differences between leases (for example, many investors supported that distinction because, in general, they view real estate leases as economically different from other leases).
The main feedback that the IASB said it received on the 2013 exposure draft was that the dual model proposed was too complex. Some commenters suggested reverting to a single model,, while others suggested a dual model that retained the existing distinction between operating and finance leases.
“In practice, the difference in the IASB and FASB positions is expected to result in little difference for many lessees for portfolios of leases,” said the IASB. “So why reach different decisions? In reaching its tentative decisions, the IASB carefully considered the information that would be provided to investors and analysts, as well as conceptual considerations and operational cost and complexity. Information for investors and analysts: link between the balance sheet and the income statement. On the basis of feedback received, the IASB concluded that a model that separately presents interest and amortization for all leases recognized on the balance sheet would provide information that is useful to the broadest range of investors and analysts. This is because most investors and analysts consulted think that leases create assets and debt-like liabilities for a lessee.”
The IASB contended that its model is easy to understand. A lessee would simply recognize fixed assets and financial liabilities, and the corresponding amounts of amortization and interest. The IASB model also avoids any structuring that might arise from having different accounting for different leases, which the IASB said was a concern expressed by some investors and analysts. The IASB said it expects to issue a new leases standard in 2015.
FASB, for its part, favors its own approach. “The IASB and the FASB have reached consistent conclusions on important areas of lease accounting, but some important differences remain—most notably in our preferred approaches to expense recognition,” said FASB spokesman Robert Stewart. “At our joint meeting in March, the FASB voted to keep its current two-tier model for expense recognition. The FASB favored retaining its current expense approach—in which expenses for capital-type leases would be front-end loaded’ and expenses for most real estate and similar leases would be straight-lined.’ The FASB believes that approach more appropriately reflects the economics of lease transactions and, based on what was heard from U.S. stakeholders, it is more operational.
“The IASB, on the other hand, reverted to the original approach in the joint exposure draft that front-loads expenses by the lessee for all lease contracts,” Stewart added. “Specifically, all leases would, in effect, be treated primarily as financing transactions.”
Dr. Nigel Sleigh-Johnson, head of the Financial Reporting Faculty at the Institute of Chartered Accountants in England and Wales, pointed out Friday that the IASB’s update on its lease accounting project reveals how a new model is emerging after eight years of debate and deliberation on how to bring leases onto the balance sheet. The IASB has changed its stance on how leases should be categorized, and the international standard setter is heading in a different direction than its U.S. counterpart.
“The lease accounting project is another key project in the world of accounting standard setting where views differ greatly both among standard setters, those preparing accounts and those using the accounts,” Sleigh-Johnson said in a statement. “The IASB has now decided that it will abandon the dual expense model it previously proposed, where leases were to be classified as either Type A or Type B depending on whether or not the lessee consumed a more than insignificant’ part of the underlying asset during the life of the lease. The board is reverting to a simplified version of the model first proposed in 2010. The FASB, on the other hand, is still wedded to a dual model.”
The IASB also went separate ways from FASB in key elements of another major convergence project, the financial instruments standards that the IASB released last month, particularly diverging in standards for credit losses and loan impairments (see IASB Releases Its Own Financial Instruments Standard). FASB plans to issue a financial instruments standard by the end of this year. The two boards came together in May, however, producing a largely converged revenue recognition standard.
“Some would claim that the two standard setters’ convergence efforts have floundered in this core area of financial reporting, but it is important to also remember that they agree on many very important things, such as how leases should be defined and the basic premise that assets and liabilities should be recognised for major leases," said Sleigh-Johnson. "That in itself is no small an achievement. While it looks like we won’t have one complete joint solution in the end, the actual impact of the differing models over time may not be as be dramatic as one might first think.
“The most important thing is that the new IFRS standard, when it is completed—possibly as early as next year—should help investors and analysts by removing the need for them to guesstimate the extent of a company’s lease liabilities based on the disclosures it provides in the notes to the financial statements," he added. "It will also aid comparison between companies’ reported numbers.”