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Impasse on Key Issues Puts Lease Accounting Convergence at Risk

March 19, 2014

The FASB and IASB planned to reach major conclusions on their much-watched lease accounting project, but entrenched differences between the two boards blocked progress. The boards decided to delay by one day decisions on the accounting model for lessees and lessors. But barring changes overnight, the standard-setters face a high risk of being unable to converge on a project they have worked on since 2006.

After hours of debate revealed deep divisions between the FASB and IASB on the major pieces of their proposal to overhaul lease accounting, the boards on March 18, 2014, moved to put off most decisions for a day.

Without an overnight change of heart, the U.S. and international accounting standard-setters are at risk of yet another breakdown of a project for a global accounting standard they spent years attempting to write. The lease accounting proposal is designed to force companies to recognize lease expenses on their balance sheets—a sea change from current practice and one of the boards’ last remaining convergence projects.

In the past two years, the boards have experienced failures in the efforts to write converged standards for financial instruments and insurance contracts.

“I would find it very unlikely that we overnight change positions, but miracles happen,” IASB Chairman Hans Hoogervorst told Accounting & Compliance Alert after the meeting.

FASB Chairman Russell Golden took a more optimistic approach.

“We still have a day-and-a-half,” Golden said.

The discussion clearly indicated that FASB members were in one camp and IASB members in another for the accounting for both lessees and lessors.

“I thought there would have been a lot of behind-the-scenes talking and negotiating to try to get a consensus at some level, but holy cow,” said George Yungmann, senior vice president of accounting standards at the National Association of Real Estate Investment Trusts. “I was surprised about how each board is very dug in.”

The March 18 discussion was supposed to be a turning point in the FASB and IASB’s effort to settle years of debate and controversy on lease accounting, which long has been criticized as allowing companies to mask significant expenses by not requiring them to record lease liabilities on their balance sheets.

The boards in May 2013 released largely converged proposals via the FASB’s Proposed Accounting Standards Update (ASU) No. 2013-270, Leases (Topic 842), and the IASB’s Exposure Draft (ED) No. 2013-5, Leases, and both boards started redeliberations this year.

The proposals called for companies to recognize things like rented storefronts and fleets of trucks as assets and the contractual payments for them as liabilities. The draft standards divided leases into two categories—those akin to rentals and those similar to financing arrangements. Companies would draw the distinction based on how much of the asset is consumed over the life of the contract.

An asset with most of its life left at the end would be recorded in a manner that’s similar to a rental expense, with even payments over time—a “Type B” lease. A leased asset where most of the life is used up would be accounted for as a financing transaction—”Type A.” As a shortcut, the boards decided that almost all leases of office buildings or storefronts would receive the even, or straight-line, expense-recognition treatment, while almost all leases of equipment would receive financing treatment, with interest and amortization calculated with the rental expense. Because interest is calculated on a declining balance over time, the cost to rent a piece of equipment would look more expensive at the beginning of the lease term.

All but one FASB member—Harold Schroeder—on March 18 remained committed to keeping this distinction. A strong majority of IASB members favored requiring a single approach to lessee accounting, which would result in almost all leases being treated as financing transactions.

The difference seemed to hinge on the fact that most IASB members considered lease arrangements to be akin to ownership. Most FASB members don’t agree.

“In situations like this, where there are no clear cut answers, one of things I find helpful is to return back to a basic objective of what is it that we’re trying to accomplish, and it’s clear that the original, primary objective we’re trying to accomplish is simply to record lessee liabilities on the balance sheet,” FASB member Daryl Buck said. “Doing that in the least disruptive manner seems to be the best path forward.”

IASB members, however, said treating almost all leases like financing transactions would be the most conceptually pure answer and, ultimately, the simplest.

“If we want to get this through, we have to be as conceptually sound as possible,” Hoogervorst said.

The boards also were unable to agree on lessor accounting and said they would return to the discussion on March 19.

Originally an afterthought because there were few complaints about lessor accounting, the boards found writing a model for lessors to be just as difficult as writing a model for lessees. The challenge was reflected in the hundreds of comment letters the boards received on their proposals, with many auditors, accountants, and businesses saying the lessor accounting proposal was too complex.

The 2013 proposal divided lessor contracts into those that are similar to financing transactions and those that are basic rental arrangements. Most landlords renting out land or buildings would be considered to have rental arrangements, but companies that rent out heavy equipment or railcars would have to account for the arrangements as financing transactions.

The FASB and IASB research staffs tried to steer the boards toward scrapping this part of the proposal and calling on a lessor to make the assessment about renting versus financing based on whether the lessor transfers substantially all the risks and rewards incidental to ownership of the underlying asset. For a transaction that does not transfer control of the underlying asset to the lessee, the lessor would follow the FASB and IASB’s separate, forthcoming revenue recognition standard.

All seven FASB members agreed with this approach, but most IASB members instead wanted to stick with guidance in IAS 17, Leases.

The boards decided to vote on the question on March 19.

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