Conceptual differences hamper lease accounting project

by Naomi Rainey

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15 Jul 2014

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AN INTERNATIONAL PROJECT, a multi-trillion dollar global industry, political tension and conceptual differences between the IASB and FASB: it's a heady mix at the heart of the lease accounting debate.

The global and US standard setters' leasing project - much like the successfully converged revenue recognition standard issued in May - has been a long time in the making, and there is little sign of a resolution any time soon. Disagreements between the two boards mean the final standard is unlikely to take shape until next year.

The project was launched back in 2006 when convergence was still a buzzword. A discussion paper was released in 2009 and two exposure drafts followed in 2010 and 2013. However, the accounting rulemakers have since been forced to return to the drawing board after plans, put forward last year, to overhaul lease accounting so that all but the shortest leases are accounted for on company balance sheets were roundly rejected by businesses and preparers.

The 2013 exposure draft proposed that lessees should recognise a right-of-use asset and corresponding liability for all leases with a term exceeding 12 months. But in response to protests from some constituents that leases of different types of underlying asset result in different economics, the document treated leases of equipment - known as type A leases - differently from leases of real estate - known as type B leases - in the income and cashflow statements.

While the two boards hammer out the details of the repurposed standard, European standards advisory group EFRAG has launched its own consultation into how leases should be treated - and which (if either) of the board's proposals is preferred.

Conceptual differences
Since joint proposals were published last year that applied a dual approach to the recognition, measurement and presentation of expenses and cash flows arising from a lease, the two boards have a developed a "conceptual difference of opinion" over the models.

"FASB believes its accounting and its approaches better represents the economics, but we think what we've suggested better reflects leasing economics," says IASB board member Stephen Cooper.

FASB and the IASB agree on the main objective and on many important issues, such as how leases are defined and short-term exemptions, but continue to debate the method of accounting used to put these figures on the balance sheet. While the IASB proposes a single model in which assets and liabilities are amortised on a straight-line basis using effective interest rate, FASB proposes a split between purchases and operating leases.

Amortisation leads to a mismatch in profit and loss due to the reducing charges over the life of the asset, which is disliked by businesses and preparers, explains Veronica Poole, global IFRS leader at Deloitte. Under FASB's compromise, leases that are not in substance purchases would continue to be accounted for in a way that provides the same P&L as lease rentals do today.

"The difference is really what happens in the P&L," Poole says. "The IASB has identified the definition of the lease and argue the unmatched P&L profile is appropriate, but FASB has said, ‘but some of them are in substance purchases and some of them are not'. So you get a different P&L, but on the balance sheet they look the same."

While the international and US standard setters have come to enough agreement to get through two exposure drafts, there are still some who question whether the change should be made at all.

A controversial area
The massive volume of lease contracts is both the biggest reason for, and the biggest challenge, to the IASB and FASB's plans to overhaul the current standard, while intensive lobbying from the US leasing industry and the risk of a European carveout have hampered to developments.

While investors have been vocal about their desire to see the hidden leverage of leases on balance sheets and standard setters have long recognised the need to properly reflect lease obligations in accounts, the behemoth leasing industry and some companies and account preparers are yet to be convinced about the cost-benefit balance in changing the system.

"Investors want items on the balance sheet, and standard setters agree that is technically right. But then there is the question of practicability - there are so many contracts. They're not done at an accounting level, so there's a question of whether we even have systems to capture and analyse the data properly," says Poole.

"There's also the issue of whether businesses can afford to have diverged solutions. Today, even if lease accounting isn't perfect, it's pretty much converged. Do we want that to change?"

The boards are currently tasked with finding a practical solution that balances the competing pressures from industry lobbying, investor demands and concerns from preparers over the cost-benefit, Poole says.

"FASB has gone one way, with their dual model, and the IASB are going single-model but with some exemptions for short-term leases and small-ticket items. Both are looking to find practicable solutions, they've just diverged how they're doing it," she says.

Cooper at the IASB acknowledges that leasing is "a controversial area", but says there is a huge value to investors for having comparable information about companies around the globe. That value has the best chance of being realised if the standards are "endorsed and adopted in every jurisdiction without modification", Cooper says.

Carve out risk
While debate between the boards continues, European standards advisory body EFRAG, of which the FRC is a member, is seeking views on the proposals as they stand.

FRC director of research, codes and standards Andrew Lennard says the consultation is primarily focused on two elements: whether FASB and IASB's lease proposals will "inadvertently" change treatment of service agreements and "whether that would be appropriate"; and which of the current plans is the preferred model for lease accounting.

The results of the consultation will be reported into the IASB ahead of meetings in the autumn. While concerns have been raised by the UK and Germany about the impact of FASB and IASB's plans, suggestions the consultation is pre-empting a European Union carve out would be "getting ahead of ourselves", Lennard says.

"Once IASB has issued a standard there will have to be a debate about whether it should be endorsed in Europe," he says. "At the moment we're simply trying to make sure we give constituents the opportunity to express their views so we can make sure the right standard is produced."

He adds: "When we come to have the endorsement debate, if the standard is not felt to be of a high quality, that would figure in that debate."

For Cooper, the quality of the model is not an issue. "There's nothing that suggests to me that any of the standards we're working on at the moment aren't fit for working on a global basis," he says.

A bigger challenge for Europe will be proving the broader EU public good is met by adopting the standard, Poole says. "Does the cost of implementation justify the benefit? The benefit is assessed in many different ways. Europe will have to assess the cost of implementation vis a vis the benefit. They have to say it's a change for the better even with the cost of implementation."

Regardless of the outcome, the consultation will "hopefully" show whether Europe want convergence on leasing standard "and whether they're prepared to converge around the FASB model", Poole adds.

IASB is re-deliberating the second exposure draft and is due to finish in "a few months", Cooper says. Beyond this, there will be a period of drafting and review of the final standard, which is likely to push publication into "sometime next year".

Consultation remains a big part of the process in the coming months, but at some point "the process has to stop", Cooper says. "We can't keep going on talking about something and not making a decision."

Despite the uncertainty and some formidable detractors, Poole says there is a certain level of "acceptance" that leasing changes will go ahead. "The interesting challenge is to find an answer that is practically workable," she adds.

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Financial Planning and Performance AnalystCabinet Office-Greater London-Competitive

 
 
 
 
 
 
 
 

 

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