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Lease Accounting Debate Shifts to Minimizing Differences Between GAAP and IFRS

April 15, 2014

The FASB and IASB disagree on a significant part of their lease accounting project, and the boards’ plans to use an upcoming meeting to minimize their differences on some second-tier issues may not augur well for the prospects of producing a converged standard for IFRS and U.S. GAAP. The new focus is a significant departure for an effort that has been on the boards’ shared agenda for most of the past decade.

The FASB and IASB remain deadlocked on a major part of the lease accounting project, but the boards hope to reach a consensus on at least some of the smaller aspects of the much-watched project.

Discussions scheduled for an April 23, 2014, joint meeting include accounting for changes to the terms of a lease contract, determining when it is appropriate to combine two or more contracts, calculating variable lease payments, fixed payments, and how businesses should determine the discount rate for measuring liabilities.

The key phrase, according to agenda papers released ahead of the meeting, is “minimizing differences between U.S. GAAP and IFRS.”

The emphasis is a significant change from the project’s original goal—global accounting convergence. The standard-setters took up the lease accounting project to address a decades-old complaint that companies mask substantial liabilities by not revealing the costs of rented real estate, equipment, and vehicles on their balance sheets.

The boards released mostly converged proposals in May 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.

While the FASB and IASB agree that they want companies to own up to lease expenses on their balance sheets, the boards are at loggerheads on what they call the day-two accounting issues—how to treat the companies’ income statements.

The divide was clear in March, when six of the seven FASB members wanted one treatment, and a strong majority of IASB members wanted another.

At the end of the two-day meeting, FASB Chairman Russell Golden said the U.S. board’s research staff would continue to research some of the issues that caused the disagreements. Given the votes, however, the odds of coming to a consensus on the income statement issue appear slim. (See Golden Says Study of Leasing Issues May Keep Convergence Effort Alive in the March 20, 2014, edition of Accounting & Compliance Alert.)

The accounting standard-setters continue to hope they can settle the second-tier issues.

On lease modifications, the boards are scheduled to discuss how to identify a lease modification, when a modification should be accounted for as a new lease, and how to account for lease modifications that are not separate, new leases. The boards also plan to lay out guidance on when to combine two or more contracts.

For variable lease payments, the FASB and IASB’s research staff are recommending that initial measurement of the payments include only variable lease payments that depend on an index or interest rate. The staff also is recommending that a lessee would reassess variable lease payments that depend on an index or rate only when it is reassessing the lease liability for other reasons, such as significant changes in circumstances, as opposed to on a regular basis.

The boards also want to hammer out how to account for variable lease payments that are considered in-substance fixed payments. Current U.S. GAAP and IFRS doesn’t include guidance on when, if ever, variable lease payments that are in-substance fixed payments should be included within the definition of “minimum lease payments.” The concept, however, is well established in current practice, according to agenda papers.

Finally, the boards want to settle how companies determine and then reassess a discount rate when they measure their lease liabilities. They want to settle the same issues for lessors that rent out real estate and equipment to the businesses.

The 2013 proposals called for lessees to discount their lease liabilities at the rate the lessor charges. Otherwise, the lessee is supposed to use its incremental borrowing rate. The rate the lessor charges the lessee should take into account the nature of the transaction as well as the terms and conditions of the lease.

Discounting is commonly used to estimate the current value of future costs.

After the April joint meeting, the FASB and IASB have at least two more joint lease discussions planned, according to a schedule laid out in the agenda papers.

The boards in May plan to discuss the definition of a lease, separating lease and non-lease components, and initial direct costs and lease incentives.

In June, they’re scheduled to discuss residual value guarantees, subleases, and sale and lease-back transactions.

The schedule does not show that the boards plan to revisit the income statement issue that has divided them.

Before issuing a final standard, the boards also will have to talk about presentation, disclosure, transition, the new standard’s effective date, and other remaining issues. Separately, the FASB has to discuss private company and not-for-profit accounting issues, and its staff is recommending that it discuss the accounting for leveraged leases, which receive special treatment in U.S. GAAP but don’t exist in IFRS. The boards’ June 2013 proposals scrapped the concept of leveraged lease accounting entirely.

A leveraged lease is typically used when a company finances the purchase of a big-ticket item like an airplane or wind turbine and then leases it to another business. The lessor can take advantage of tax deductions for depreciation costs or investment credits and pass along the savings to the lessee. Proponents of leveraged lease accounting say it’s a tool that helps present investments in a leveraged lease on a net basis and recognize income on an after-tax basis.

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