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Big Four Auditors Pan Lease Proposal

Sep 18, 2013

Add the Big Four audit firms to the list of critics of the FASB and IASB’s controversial lease accounting project.

PricewaterhouseCoopers International Ltd., KPMG LLP, Ernst & Young Global Ltd., and Deloitte Touche Tohmatsu Ltd. in written comments to the FASB and IASB questioned the merits of the boards’ proposal to force almost all leases on company balance sheets, saying the plan is so complicated it will not improve existing accounting standards.

The Big Four firms are in good company. The lease accounting proposal, which the FASB and IASB released in May via the FASB’s Proposed Accounting Standards Update (ASU) No. 2013-270Leases (Topic 842), and the IASB’s Exposure Draft (ED) No. 2013-5,Leases, has been criticized from almost all corners.

The FASB approved releasing the proposal by a narrow 4-3 margin, which is an unusual amount of discord for such a high-profile standard, and the board remains divided on whether the long-running effort to overhaul lease accounting represents the standard-setters’ best effort.

Each of the firms said they agreed with the goal of developing a single, simpler approach to accounting for leases and requiring the assets and liabilities associated with leases to be recognized in company financial statements. But the FASB and IASB fell far short of the mark, they said.

KPMG said the boards settled “for the least bad compromise.”

Bringing leases on company balance sheets “should not be seen as an end in itself, to be pursued at any cost,” KPMG wrote. “We believe the current proposals do not represent an improvement over current GAAP, will not satisfy users, and will not justify the costs of implementation and ongoing application. Change for the sake of change does not necessarily equate to progress. We believe the boards should aim for a high quality accounting standard, not settle for the least bad compromise.”

The FASB and IASB’s proposals are expected to usher in a major change in the way companies account for their leases.

Under U.S. GAAP and IFRS, most companies treat their leased property and equipment as rental arrangements, which are not recorded on their balance sheets. Critics have long complained that an airline that leases its planes or a department store that rents its retail outlets has financial liabilities that are as large as the companies that finance them, and the costs should be made transparent. The proposals attempt to address this criticism by calling for businesses to record almost all leased items—anything from storefronts to fleets of trucks—as assets and the payments as liabilities on their balance sheets.

But the FASB and IASB agreed that not all leases are the same, and therefore they should receive different accounting treatment in their income statements. This is where the proposal gets complicated, and where much of the criticism originates.

An asset with most of its life left after the contract would be recorded in a manner that’s similar to a rental expense, with even payments over time. A leased asset where most of the life is used up would be accounted for as a financing transaction.

For simplicity’s sake, the boards decided that almost all leases of real estate would receive the even, or straight-line, expense-recognition treatment, while almost all leases of equipment would receive what is called a front-loading of expenses. This has raised the ire of companies that lease large items such as railway cars or oil tankers, which they say can have decades of life and are more akin to real estate than equipment that breaks down after a few years.

The audit firms also criticized the reasoning behind the different income statement treatment depending on the type of leased item.

“A criticism of the current leases guidance is that similar transactions receive different accounting treatment. The ED does not resolve that issue,” E&Y wrote. “Instead, the ED would create new and unfamiliar dividing lines between types of leases that would add new complexity in place of an old one.”

In addition, the accounting for real estate leases is significantly more complex than the accounting for those arrangements under existing guidance, E&Y wrote.

“The proposed lessee model—for both Type A and Type B leases—would introduce new complexities,” E&Y wrote. “In particular, the requirement for lessees to reassess and remeasure lease liabilities on an ongoing basis would give rise to significant costs… that are not present today.”

Deloitte also raised questions about the conceptual merits of the two types of leases and said the resulting information would not be useful to investors and securities analysts.

“Specifically, users are trying to understand the full extent of a lessee’s commitments under existing lease contracts, which may not be fully conveyed under the proposal,” Deloitte wrote. “As a result, to arrive at data necessary for their analysis, users may have to remove the amounts recorded under the proposal from the financial statements and then make adjustments similar to those that are currently made.”

Deloitte said the boards may better serve the needs of investors by requiring additional information about lease liabilities in the footnotes of company financial statements.

PwC’s comment letter appeared to direct the least criticism toward the proposal, but the firm didn’t praise it, either.

The split between the two different types of leases based on the pattern of consumption is “lessor-focused and typically not relevant or intuitive for many lessees,” PwC wrote. “We also do not find the presumptions applicable to ‘property’ and ‘other than property’ to be sufficiently neutral or decision-useful for many users.”

Existing guidance in IAS 17,Leases, would serve as a better way to determine the difference between different lease types, according to PwC.

Comments on the FASB and IASB’s proposals were due September 13, 2013. The boards expect to start reviewing the comments and making changes to the proposal later this year. A final standard is not expected until 2014 at the earliest.