PROPOSED changes in the lease accounting standards by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) are expected to have a limited impact on truck and trailer leasing activity, according to PacLease Corporate Services Manager Brent Stevens and others in the industry.
As a result of the Exposure Draft issued by FASB and IASB last August, over 750 comment letters were received — most of them highly critical of the proposals — and FASB and IASB have made tentative changes that soften the impact.
“Expectations are that there will be considerable movement in the rules when they're finally published,” Stevens said, referring to an estimated publishing date of late-2011. “I think there will be much simpler rules for the industry, although I can assure you that operating leases as we know them today will be eliminated and will be brought on balance sheet. That will have a significant impact on the accounting/financial reporting of leases.
“But a lot of complexities included in the Exposure Draft look like they are on the way out. One of the key things was that the expense recognition pattern that had been included in the Exposure Draft was going to result in some frontloading of expenses. Now the boards have tentatively decided that for leases that are currently called operating leases, they'll allow level expense recognition. That's a good change for the industry.
“Then there's determination of the lease term. Before, they had a rather complex method, which required lessees to determine the probability of occurrence for each possible lease term. Now they've gone back and tentatively decided that the lease term will be the non-cancellable term defined by the lease contact, plus any options to renew that are economically likely to occur.”
Stevens said that the critical aspect for truck and trailer leasing is that the economics of the lease will really be no different.
“They're not affected by adoption of these new rules,” he said. “The economics are still there. If you do a financial lease versus buy net present value analysis, there's no change, as the analysis is based on the after-tax cash flows, which are not impacted by a change in financial reporting. Now it appears the impact on the expense stream may be little if any, compared to current operating lease accounting.
“Trailers tend to be leased for longer terms than power equipment. Under the rules as they were originally proposed, there would have been more impact from an expense recognition standpoint. There would have been more frontloading. But under the new proposed rules, there probably will be little impact to trailer leasing.”
Stevens is recommending that companies review the potential impact of capitalizing current operating leases on their debt ratios and how that may impact loan covenants contained in their lending agreements.
The boards are holding several meetings, the most recent on March 21 and 22, at which they discussed changes to the Exposure Draft:
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Lease term
FASB and IASB have tentatively decided that the lease term should be defined, for both lessees and lessors, as follows: “The lease term is the non-cancellable period for which the lessee has contracted with the lessor to lease the underlying asset, together with any options to extend or terminate the lease when there is a significant economic incentive for an entity to exercise an option to extend the lease, or for an entity not to exercise an option to terminate the lease.”
The boards tentatively decided that a lessee and a lessor should reassess the lease term only when there is a significant change in relevant factors such that the lessee would then either have, or no longer have, a significant economic incentive to exercise any options to extend or terminate the lease.
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Types of leases and the definition of a lease
FASB and IASB discussed types of leases and the definition of a lease and directed the staff to seek input through targeted outreach on the approaches detailed below. The purpose of the outreach is to: obtain a better understanding of the implications of any proposed changes to the Exposure Draft.
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Types of leases
The boards tentatively decided to identify a principle for identifying two types of leases for both lessees and lessors, with different profit and loss effects, as follows: a finance lease with a profit or loss recognition pattern consistent with the proposals in the Exposure Draft; an other-than-finance lease with a profit or loss recognition pattern consistent with an operating lease under existing US Generally Accepted Accounting Principles (GAAP) and International Financial Recording Standards (IFRS).
The boards tentatively decided to establish indicators to distinguish a finance lease from an-other-than finance lease. They asked the staff to use these tentative decisions to perform targeted outreach to determine if stakeholders' concerns about the profit and loss recognition pattern proposed in the Exposure Draft would be addressed.
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Definition of a lease
A lease is defined as a contract in which the right to use a specified asset is conveyed, for a period of time, in exchange for consideration. The Exposure Draft included two principles relating to that definition to help to assess whether a contract contains a lease: the fulfillment of the contract depends on providing a specified asset or assets; and the contract conveys the right to control the use of a specified asset for an agreed period of time.
The boards expressed support for defining a specified asset as an asset of a particular specification. They also discussed an alternative approach that defines a specified asset as a uniquely identified or identifiable asset, which is closer to the application of current requirements in IFRS and GAAP. The boards will seek input on both approaches.
They expressed support for specifying that a contract would not contain a lease if an asset is incidental to the delivery of specified services.
They expressed support for clarifying that both physical and nonphysical portions of a larger asset can be specified assets. The boards tentatively decided that such a clarification would be made only in conjunction with revising the definition of the right to control the use of an asset. This is to maintain consistency with how control is articulated in the revenue recognition Exposure Draft, Revenue from Contracts with Customers.
The Exposure Draft proposed that the right to control the use of an asset is conveyed if any one of three particular conditions is met. Comments received from respondents suggested that the third condition (set out in paragraph B4(c) of the Exposure Draft) raised a number of questions about its application. Some respondents also questioned why control was defined differently in the Exposure Draft than in other publications. The boards expressed support for an approach that defines the right to control the use of an asset consistently with how control is articulated in the revenue recognition Exposure Draft. This approach would state that a customer has the right to control the use of a specified asset if it has the ability to direct the use, and receive the benefit from use, of the asset throughout the lease term.
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Variable lease payments and other lease payment considerations
The boards considered which variable lease payments should be included in the lessee's liability to make lease payments and the lessor's right to receive lease payments. Variable lease payments include any lease payments that arise under the contractual terms of a lease because of changes in facts or circumstances occurring after the date of inception of the lease, other than the passage of time.
The boards tentatively decided that: the lessee's liability and lessor's receivable should include lease payments that depend on an index or rate, lease payments for which the variability lacks commercial substance, and lease payments that meet a high recognition threshold (such as reasonably certain); variable lease payments that depend on an index or a rate should be measured initially based on the spot rate; recognition of variable lease payments by a lessee and lessor should be subject to the same reliable measurement threshold. (However, the need for such a threshold will depend on the basis for recognizing variable lease payments.)
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Residual value guarantees
The boards tentatively decided to clarify that the lease payments should include amounts expected to be payable under residual value guarantees, except for amounts payable under guarantees provided by an unrelated third party.
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Term option penalties
The boards tentatively decided that the accounting for term option penalties should be consistent with the accounting for options to extend or terminate a lease. That is, if a lessee would be required to pay a penalty if it does not renew the lease and the renewal period has not been included in the lease term, then that penalty should be included in the recognized lease payments.
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Confirmation of the right-of-use model
The boards affirmed the decision in the Exposure Draft to apply a right-of-use model to all lease arrangements. Under that model, a lessee in an arrangement that is, or contains, a lease would recognize an asset representing its right to use an underlying asset during the lease term and a liability representing its obligation to make lease payments during the lease term. Application of the right-of-use model by a lessor will be discussed at a future meeting.
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Scope
The boards tentatively decided that leases of intangibles are not required to be accounted for in accordance with the leases standard. The boards affirmed the decision in the Exposure Draft that the following are within the scope of the leases standard: right-of-use assets in a sublease; leases of non-core assets; and long-term leases of land.
The Boards affirmed the decision in the Exposure Draft that the following are not within the scope of the leases standard: leases for the right to explore for or use minerals, oil, natural gas, and similar non-regenerative resources; leases of biological assets, including (US GAAP only) timber; and (IFRSs only) leases of service concession arrangements within the scope of IFRIC 12, Service Concession Arrangements.
Current lease accounting, known as SFAS 13-US GAAP, was established in 1976. FASB and IASB announced a convergence plan in October 2002, with a stated goal of developing a consistent group of acting standards.
The boards originally wanted to issue final rules by mid-2011, but Stevens says he's heard from sources that it will be late-2011, with implementation of new lease accounting rules early in 2015. ♦
