The Financial Accounting Standards Board and the International Accounting Standards Board are not seeing eye to eye on an important component of their leasing standards project involving income statement changes for lessees.
At a tense meeting in London on Wednesday, the two boards voted for differing approaches. “There was a fair amount of frustration at the board table,” acknowledged FASB chair Leslie Seidman.
However, since the leasing standards are expected to be re-exposed for further comment, the two boards hope to eventually issue a converged standard for U.S. GAAP and International Financial Reporting Standards once they hear feedback on their differing approaches from constituents and reconvene in April.
“The purpose of the meeting was essentially a discussion intended to respond to the feedback we have continued to receive about the income statement effects for lessees,” Seidman said during a conference call Thursday with reporters. “This discussion was not intended to address, nor did it address at all, the balance sheet treatment of these leases. The focus was entirely on addressing some recurring feedback we have been getting about the effect on the income statement of the model for right of use that we have been developing on certain types of leases.”
The concern, she noted, was that some of the people who submitted comments on the previous exposure draft of the standards viewed certain kinds of leases not as financings and in-substance purchases, but as operating expenses in cases where they wanted to rent a piece of property for a period of time. In cases, for example, where a business was renting equipment or property, and it did not involve a buy/lease decision, the income statement effect would be similar to a buy/lease decision.
“That was the issue we set out to address and because we received those comments on the first exposure draft, and then we received another slew of comment letters after we confirmed the approach in the exposure draft, we decided to revisit the issue now just to see if we could try and resolve this concern before we went out with a second exposure draft,” said Seidman.
However, it was not only FASB and the IASB that disagreed on the approach to take; some members of FASB were split. Still, the majority of the FASB members supported an approach known as the “interest-based amortization method,” under which leases that transfer substantially all of the risks and rewards of the risked asset would be accounted for under a right of use model that had been previously agreed upon by the board.
“It was the right of use model that was in the exposure draft and then reconfirmed during our redeliberations, but with some of the modifications with respect to things like contingent rents,” said Seidman. “For leases that did not transfer substantially all of the risks and rewards of ownership, those would be recognized on the balance sheet at the present value of the expected lease payments, just like the others, but they would be amortized using an approach that would generally result in recognizing total lease expense on a straight-line basis.”
She added that would not be true in every case, for example, if a business had uneven lease payments or rent holidays. But if it had a level pattern of lease payments, then the total lease expense would be on a straight-line basis.
However, the IASB voted for a different model. “The IASB supported a new approach for all leases that would recognize leases on the balance sheet at the present value of the expected lease payments, just like the FASB, but in the model they voted for, the right of use asset would be amortized based on the estimated consumption of the value of the underlying lease asset,” said Seidman. “So this is the new part, and there is a formula that you would use to apply it. You would come up with a percentage of consumption that’s estimated, and then you would apply that to the fair value of the underlying asset, and that would represent your lease expense in any period. So the higher the rate of consumption that is estimated to be used through the lease, the more the income statement is going to look like a purchase and a financing, which makes sense, because it looks similar to owning the underlying, but it’s proportionate. The lower the rate of consumption, the more the income statement effects would resemble a straight-line pattern. But that approach, which was called the ‘underlying asset approach,’ would not result in a straight-line pattern for the majority of leases.”
Since the boards could not agree on how to move forward to address the income statement issue, they asked their staff members to conduct outreach on both approaches. The staff would hear from constituents about the usefulness of the information that would result from both approaches, how well they would operate, and report back to the boards at the April meeting.
“We also asked the staff to think about the lessor side when conducting these discussions, because there were questions raised about whether there should be symmetry between the lessee and the lessor,” said Seidman. “This discussion about the symmetry for lessors could have implications for the board’s previous decision to scope out investment properties that were held by lessors.”
FASB is concerned that the IASB’s approach represents “a new theoretical approach to thinking about leases, which we did not think was warranted at this point to address the problem that was raised,” said Seidman. “The problem that was raised was that people felt that for certain types of leases that essentially represent periodic rentals, that a straight-line pattern was appropriate. The model that the IASB was considering does not result in a level interest income effect for the vast majority of leases, so we didn’t actually think it solved the problem that was being raised.”
Another concern related to complexity of the IASB model, which involves estimation of either the fair value of the underlying asset, which FASB did not think lessees would be in a position to do in the majority of cases.
“If you think about property leases, where you’re renting an apartment or something like that, you have no idea what the fair value of the building is or what the fair value of your floor is,” said Seidman. “Then the other way to go about doing it is to estimate the percentage of consumption, which seems to be based on those same two variables, so we were concerned that it adds complexity to the model and might be difficult for companies to comply with.”
FASB felt that the IASB approach would be complex to implement for any company entering into periodic rentals of equipment or real estate, according to Seidman. Companies that were weighing buy versus lease decisions would be more likely to have the information, but Seidman still believes that FASB’s approach would be more beneficial for them from a cost benefit standpoint.
Seidman does not believe the disagreement with IASB will greatly delay their already delayed project on leasing standards. She noted that once the staff comes back with the results of their outreach efforts at the April meeting, there are only a few other remaining issues on leasing to be resolved between the two boards.
“I think we will be in a position to conclude our discussions in the second quarter,” she said. “To me that is not a material delay.”
The extra consultations may push back the timeline by another month, a FASB staffer noted, but FASB will probably still issue the new exposure draft of its leasing standards in the late second quarter or the early third quarter.
“I always have been of the view that if we can make a small investment of time and effort upfront to resolve concerns that have been identified, it will save us all time in the long run,” said Seidman.
Seidman acknowledged that there was frustration at being unable to agree on the issue with the IASB at Wednesday’s meeting.
“We have managed to stay side by side with converged decisions on this project throughout,” she said. “The reason is we felt that both of our standards needed to be improved. We started the project at approximately the same time and we’ve worked in a coordinated fashion to try and arrive with a converged, improved solution, so that’s why I would find it particularly disappointing to diverge at this point in time. There was a fair amount of frustration at the board table. It seemed like it would be very difficult to reconcile, but the way I feel about is that the model that the IASB gravitated toward is a new model. It’s sort of graduated, where it would tend to show more of a flat or straight-line pattern when the consumption of the asset is low, and more of an accelerated pattern when the consumption of the asset is high. The FASB just decided to be more direct about it, and say, ‘Here is when you should have a straight-line pattern, and here is where you should have an accelerated pattern.’ That’s why I’m hoping the feedback we get will help us find common ground.”
As for what effect the disagreement will have on the Securities and Exchange Commission’s delayed decision on whether or not to incorporate IFRS in the U.S. financial reporting system, Seidman pointed out that the two boards are still making progress.
“The SEC has said that they want to see significant progress made on the four remaining projects,” said Seidman. “They certainly have not given us any deadlines per se on any of the projects. They just want to see steady deliberate progress being made on these projects. I don’t think doing this extra work will end up with any kind of material delay.”