January 13, 2015
By Aaron S. Kaiser, CPA
Where We Are Now–The 10,000 Foot View
As most of you who are either in the business or serving the real estate industry already know, the accounting profession has been wrestling with the issue of promulgating a unified (FASB and IASB) revised lease accounting pronouncement. It’s been almost 10 years already since the two boards (and to some degree, the SEC) decided this was necessary. The first joint board exposure draft was issued in August 2010 and we are already past the comment period on the second exposure draft and expect to see yet a further revised draft during Q2, 2015. The most recent FASB meeting to deliberate took place in mid-December, 2014. There are 3 things that have become clear as of now:
- From a lessee standpoint, the FASB has capitulated to the IASB and agreed that any final FASB pronouncement will require that ALL leases (except for leases which are either trivial in size or shorter than a year in duration or those that involve certain arcane classes of assets (e.g., ”biologic assets”)) WILL be reflected on the lessee’s balance sheet as both an asset (for the “Right to Use”) and liability (representing the discounted present value of the future minimum non-cancellable term lease payments to be calculated and discounted in a prescribed manner, the details of which are not intended to be part of this discussion). The IASB has for a long time been pushing its agenda that would require that ALL leases be reflected on the lessee’s balance sheet, including the types of leases that U.S. GAAP presently regards as operating leases. They seem to have won this battle with respect to the balance sheet.
- Leases will be categorized as either Type A (similar conceptually to what GAAP now consider capital leases without the bright-line numerical tests–it should, however, be noted that the elimination of those bright-line tests will result going forward in most equipment leases being capital in nature as opposed to the present day operating lease treatment, which is not good news for the equipment leasing industry whose existence largely depends on its ability to skirt the existing bright-line tests) or Type B (similar to current GAAP operating leases). With respect to Type A leases: Lessees will amortize the right of use asset over its useful life, much like any other asset, and reflect the reduction of the liability under the lease using the interest method (essentially treating the liability as analogous to an installment-payment obligation). The net impact of this, besides the geographic changes this will cause both on the Balance Sheet and Income Statement, will essentially be to front-load the “lease” expense as compared to current practice. Instead of rent, a Type A lessee will end up with amortization and interest expense. If the lease is a Type B lease (which 99% of real estate leases will turn out to be), then the amortization of the asset and winding down of the liability recorded will be done in such a manner so as to leave the income statement unchanged from the manner in which we currently practice. In other words, a lessee will end up with a straight-line singular rent expense charge on its income statement, same as it would currently under operating lease accounting. So–a lot of monkeying around with the balance sheet, but the income statement will be not impacted, because the accounting will “plug” the result to get there.
- There will NOT emerge a fully converged FASB-IASB pronouncement from this entire long-term process. The FASB is leaning on the Lessor side to treat Type A leases as either financings (as presently with financing leases) or sales (similar to present practice but with changes conforming to the new revenue recognition standards). Lessor accounting for Type B leases (99% of real estate leases will qualify) will be essentially unchanged from present practice. Certain types of transactions (such as sale-leasebacks/build-to-suit transactions) will require differing analysis under the proposed new rules–and possibly yield different results.
Obviously, there is a lot of detail and enhanced disclosure requirements that have yet to be finalized. But, you get the idea where this project is headed.
As I stated up-front: We are likely to have a standard sometime in 2015. The present discussion would suggest a few years for implementation–since the standard, once implemented, will either be on a full- or quasi- (short-cut) retrospective application of the new principles. Public companies may have to go back 3 or 4 years to conform and that will be a task. Figure 2017 or 2018 for public companies and 1 year later for private ones.
Final observation: As I wrote in this space a few years ago, the major beneficiaries of these changes will be those financial institutions who will be able to assess fees of their customers for the privilege of rewriting the covenants to their loan agreements to account for the geographic changes which will be mandated. I humbly submit that all this effort and work has been expended to solve a non-existent problem, but that’s just my opinion. We are witnessing the triumph of the pen over substance.