FASB Floats Early Ideas on Private Company Accounting

If private companies should have different accounting standards, the Financial Accounting Standards Board is looking for ideas on how those differences should be established. FASB published some early ideas for how financial reporting requirements should be differentiated for private companies, and it is looking for feedback on that preliminary thinking before moving to the next step.
The “invitation to comment” published by FASB maps out six critical issues that differentiate private companies from public companies, leading to the conclusion that accounting requirements for private companies should differ as a result. FASB says the type and number of users for financial statements are different for private companies than public companies, and they have more direct access to management to ask questions. Private companies have different investment strategies, and different ownership and capital structures. They have thinner resources than public companies to manage the accounting function, and as a result it takes them longer to get up to speed on new accounting pronouncements.
As a result of those differences, FASB says, the accounting rules for private companies might logically differ in some key areas, including recognition and measurement, disclosures, and presentation. It might also be reasonable to give private companies longer lead times to adopt new standards as they are issued, FASB says. That's a broad view of the framework FASB is considering, but the board looking for feedback on that line of thinking before proceeding with a final framework.
In the meantime, the Financial Accounting Foundation is forming the Private Company Council to help identify where differences in accounting standards might be appropriate for private companies to reduce the cost and complexity of preparing financial statements that comply with U.S. Generally Accepted Accounting Principles. FASB and PCC will consider feedback to the invitation to comment and finalize the framework before they begin writing any new standards for private companies. FASB is looking for feedback by Oct. 31.
In a separate project to gather feedback on business combination rules, FAF also is looking for users of financial statements, preparers, auditors, academics, and regulators to participate in a survey that willassess the effectiveness of Financial Accounting Statement No. 141R: Business Combinations. FAF is conducting its latest post-implementation review of FAS 141R, now contained in the Accounting Standards Codification, to determine whether the standard achieved what was intended. FAF is asking those interested in participating to register online.


http://www.complianceweek.com/fasb-floats-early-ideas-on-private-company-accounting/article/253288/

Mazuma Capital Partners: Lease Accounting Standards Talks Still Underway

Mazuma Capital Partners: Lease Accounting Standards Talks Still Underway:

Hitting an impasse over how to account for short-term, rental-like leases, the Financial Accounting Standards Board and the International Accounting Standards Board will regroup next week to discuss their findings after additional research on an eleventh-hour proposal.


FASB and IASB are in the home stretch of redeliberating a new accounting standard for how to account for all leases to bring them on the balance sheet and banish the bright-line distinction between operating leases and capital leases. The boards have long wrestled, however, with how to develop a straightforward method to account for leases like today's operating leases, which tend to represent short-term arrangements for limited access to a given asset bearing little resemblance to the purchase of the asset. They are trying to put the finishing touches on a revised proposal so that it can be issued for a fresh round of comments and wrapped up by 2013.

New Leasing Proposals Continue to Draw Heat

FASB and the IASB respond to criticism as they prepare a new exposure draft for lease accounting.

The lease accounting debate rages on as the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) pore over nearly 800 public comment letters that question proposed new leasing standards. Board officials hit the conference circuit last month to answer detractors, clarify the exposure drafts they released to the public in August 2010, and talk about adjustments they are making to the original proposals.

Among the topics continuing to grab plenty of attention is the “right-of-use” asset concept, which, if approved, would require companies to capitalize operating leases they could traditionally keep off their balance sheets, such as those for real estate and equipment. The boards are also modifying their treatment of lease-renewal options, short-term leases, and variable lease payments.

Under the original exposure draft, companies would have been required to include in their lease term (and record on the balance sheet) any renewal period they were likely to exercise. Under the new proposal, lessees would account for a renewal period only if they had “significant economic incentive to exercise” that option.
In a client advisory earlier this year, Ernst & Young said such an economic incentive might include renewal rates priced at a bargain, penalty payments for relocating, or significant installment costs expended. One possible scenario suggested by Bill Bosco, a member of the IASB working group (external subject-matter experts who provide input to the board): a company that invests millions of dollars to renovate a store may be required to account for the renewal period because it would be compelled to recover its costs by extending the lease. This adjustment to the lease term, Bosco says, pushes the standard closer to current generally accepted accounting principles.
The proposed adjustments also remove some of the complexity for companies that hold leases for less than one year; under the draft rules, those short-term leases would still be considered a rent expense and would not be placed on the balance sheet. The new exposure draft also allows companies to keep certain variable lease payments off their balance sheets.
While those moves may placate some of the criticism leveled at the new proposals, one of the most controversial, and central, aspects of the lease-accounting changes has not been modified: abandoning the use of a straight-line average rent expense over a contract’s term in favor of a system requiring companies to front-load their rent expense on the income statement by splitting it into an amortization expense and an interest expense.
This aspect of the standard, Bosco says, does not reflect the reality of most leases. “We’d rather that companies’ lease costs. . .be represented in their financial statements in a way that represents the economic effect of a lease transaction, which we think is a level, monthly lease cost,” he says.
Ultimately, the proposed standard leaves more to interpretation than current rules, says Mindy Berman, managing director at Jones Lang Lasalle, a real-estate services firm. “There are a lot of subjective evaluations and a lot of nuances that will definitely affect companies’ implementation,” she says. Berman believes finance will have to partner more closely with business units to sort through them all.
The IASB and FASB plan to release the revised exposure draft for further public comment at the beginning of 2012, and hope to have a final rule in place by the end of the year.

FASB’s Leasing Convergence Timeline Moves to Next Year

Accounting Today reported that in an interview with staff members, FASB board chairman Leslie Seidman said many of the priority projects slated for convergence with the IASB probably won’t be settled until next year at the earliest.

Commenting on the completion of FASB’s re-deliberation discussions with the IASB on the leasing project, Accounting Today quotes Seidman as saying, “We are continuing to work through the issues that were raised with the exposure draft.” Seidman added, “We have already decided to re-expose that as well, which again was an extremely well-received decision because people do want an opportunity to look at the revised conclusions in the context of the standard as a whole.”

Once those discussions conclude late this fall, Seidman said the leasing proposals would be re-exposed for 120 days with the IASB. “Likewise, we’re looking at a timeframe of sometime next spring to start the re-deliberations on leasing, depending on the feedback that we get, and we’re looking at re-deliberations after that, with a goal of trying to conclude leasing in 2012,” Seidman is quoted as saying by Accounting Today.

Read entire article:

http://www.accountingtoday.com/news/FASB-Convergence-Timeline-Moves-Next-Year-60035-1.html

FASB, IASB Revert to One Model for Lease Accounting

Never mind, the Financial Accounting Standards Board has decided on its plan to allow two different accounting methods for leases. They like their original, single-model idea best after all.
In deciding how companies should account for leases, the FASB and the International Accounting Standards Board initially proposed all leases would be treated like financing transactions, with companies recognizing a liability to make lease payments and putting an asset on the balance sheet reflecting the right to use the asset for the term of the lease. Both would be measured at the present value of the lease payments. The liability would be measured in subsequent periods using the effective interest method while the asset would be amortized or written down based on the pattern of consumption and the expected future economic benefit it would produce.
Companies swallowed the treatment for long-term lease agreements that look and feel a lot like the financed purchase of an asset, but they cried foul for short-term leases that look and feel more like simple rental agreements. FASB and IASB acquiesced and agreed they would work on a two-model approach.
The boards determined “finance leases” would be treated like installment purchases, much the way today's capital leases are booked in the financial statements. “Other than finance” leases would be treated like today's operating leases, with an even amount recognized as expense each period over the life of the lease. Such a recognition pattern would more closely match the actual cash flows as companies pay down their lease obligations, companies argued and the boards conceded. FASB and IASB instructed their staff to define the criteria that would be needed to distinguish between the two types of leases.
Now, however, the boards have reversed course and decided they won't establish a two-model approach. In a joint meeting last week, FASB and IASB said they're going to stick with their original idea as described in the exposure draft for a single model for all leases. They promised to give some further thought to how to address concerns about the presentation and disclosure of information related to amortization, interest expense on the liability to make lease payments, total lease expense, and lease payment cash flows.
The lease project is one of four key accounting standards FASB and IASB are developing jointly to try to bridge major differences between U.S. and international accounting rules. The board continue to mull over how they want map out the accounting requirements for lessors as well.

See entire article:  http://www.complianceweek.com/fasb-iasb-revert-to-one-model-for-lease-accounting/article/203665/

Accounting update from ELFA

May 23, 2011: At a joint meeting on May 19, the FASB and IASB reversed recent tentative decisions in the lease accounting project as follows:

• Lessee P&L - No leases will be allowed straight line rent expense treatment but rather all leases will have be front ended lease costs equal to interest expense and depreciation of the right of use lease asset
• Lease Term - Will not be current GAAP but rather will be a lower threshold including consideration of strategic importance of asset, lessee intent and behavior in renewing in the past and will be adjusted when there are changes in judgment or circumstances
• Incremental Borrowing Rate - Lessee will use its new incremental borrowing rate to calculate adjustments when lease payment assumptions change
• Short-Term Leases - Will not be exempt from capitalization
• Lessor Accounting - Still undecided between only using a derecognition method or having both an operating lease method and a derecognition method. They are considering accreting residuals in the derecognition method.

U.S. Banks Fight Proposed Accounting Standards through IASB and FASB

U.S. derivatives accounting at odds with foreign rules
* Some bank balance sheets could nearly double
* Changes on FASB's board cloud proposal's future
Wall Street's biggest banks are urging rule-makers to scrap a derivative accounting proposal that could inflate their balance sheets by trillions of dollars.
The draft rules, unveiled by the Financial Accounting Standards Board in January, would force banks to report their full exposure for most derivatives on their balance sheets, instead of net amounts.
In a worst-case scenario, S&P 500 companies might have to bring nearly $7 trillion in derivatives onto their balance sheets if no netting is allowed, according to a report by Credit Suisse.
About 97 percent of that would come from five big banks: Bank of America Corp (BAC.N), JP Morgan Chase & Co (JPM.N), Citigroup Inc (C.N), Goldman Sachs Group Inc (GS.N) and Morgan Stanley (MS.N), according to the report. Derivatives are a big source of revenue for banks.
The proposed rules are meant to harmonize U.S. accounting standards with their international counterparts. But with new board members at FASB, the future of the proposal is uncertain.
In letters to FASB, banks complained that the change would exaggerate risks. In practice, banks typically have legal agreements in place that allow them to net, or offset their derivative positions against one another, so they are not exposed to losses on gross amounts, banks said.
"The flawed offsetting model in the exposure draft will either obscure or create nonexistent risks which will ultimately mislead financial statement users," Robert Traficanti, deputy controller at Citigroup, wrote last week.
The accounting proposal could also make it hard to net derivatives traded on clearinghouses, banks complained. One requirement for netting is that derivatives be settled simultaneously; but on a clearinghouse, derivatives are often settled in batches throughout the day.
"There is certainly concern right now about how those rules are written, and justly because there are significant implications," said Lisa Filomia-Atkas, a partner at Ernst & Young.
U.S., INTERNATIONAL RULES AT ODDS
Derivatives have come under scrutiny by regulators worldwide since the global financial crisis. Many investors complain that banks' exposures are opaque, making it difficult to determine exactly how safe a lender is.
Accounting treatment for derivatives differs sharply, with netting allowed for most derivatives in the United States but not under International Financial Reporting Standards.
Leaders of the top 20 world economies have been pushing rule-makers to iron out accounting differences.
The proposed rewrite, a joint effort of FASB and the International Accounting Standards Board, would restrict netting to limited circumstances.
"It certainly will be very onerous to meet all the netting requirements in the proposal," said Olu Sonola, director of credit policy at Fitch Ratings. "In its current form, the bar is very high."
The American Bankers Association, a lobbying group, argued that banking analysts rarely use gross amounts to figure out a company's risks. Balance sheets should report the net information, with gross amounts in footnotes, it said.
Some accounting experts, however, said it is important to see the total derivative amount on the balance sheet.
"Netting just doesn't give you a fair representation of what the company's full asset and liability exposure is," said Charles Mulford, accounting professor at Georgia Institute of Technology.
Changes on FASB's board have clouded the future of the proposed rule, which passed by a 3-2 vote. Former FASB Chairman Robert Herz, who voted for it, has resigned and been replaced as chair by Leslie Seidman, who opposed it. The board also has three new members, "so anything could happen," Fitch's Sonola said.

FASB Chair Answers Push for Private-Company GAAP

Prompted by a proposal earlier this year by a blue-ribbon panel on the future of private-company accounting standards — a proposal that includes giving oversight of those standards to a brand-new board — the Financial Accounting Standards Board has heightened its focus on private-company issues, according to Leslie Seidman, the board's chairperson.
Seidman chose the prestigious Zicklin Center Financial Reporting Conference at Baruch College in New York on Thursday to respond to the challenge from the panel. Declaring that she hopes the responsibility for private-company financial reporting remains squarely in FASB's hands, she noted that the decision about how to respond to the panel's proposal is being deliberated by the Financial Accounting Foundation, FASB's parent organization. (Ironically, the FAF, along with the American Institute of Certified Public Accountants and the National Association of State Boards of Accountancy, established the panel.)
In January the panel recommended that the FAF "create a separate accounting standards board . . . with the ultimate standard-setting authority to determine and set exceptions and modifications in [generally accepted accounting principles] for private companies." Rather than proposing the creation of a separate version of GAAP for private companies, however, the panel recommended that accounting standards for nonpublic companies be based on existing U.S. GAAP "but with exceptions and modifications that would result in financial statements that provide relevant, decision-useful information that meets the needs of users of private company financial statements in a cost-effective manner."
Seidman acknowledged hearing concerns about the relevance of GAAP to private companies and complaints that current accounting standards are "overly complex for [private company] stakeholders." The FASB chair said she "strongly support[s]" the panel's short-term recommendations related to process changes, including considering a delay for private companies of the effective date of major new standards. In fact, Seidman noted, FASB has implemented or is in the process of implementing practically all of the short-term recommendations.
For instance, the panel recommended that FASB fill at least one of its then-open board positions "with individuals who have primarily private company background and experience." In a footnote, the panel acknowledged that FASB had done that and more. On January 14, the board named two board members: Daryl Buck, who spent 18 years as CFO of Reasor's Holding Co., a private company with $400 million in annual sales, and R. Harold Schroeder, who "has substantial experience as a user of financial statements, including financial statements of private companies," in the words of the panel's proposal.
Another of the recommendations was that the differences in GAAP for private companies be based on a framework, or set of decision criteria. Seidman noted that FASB's staff has begun developing such a "differential framework" in the form of a white paper on the unique needs of the users of private-company financial statements.
Noting that she "strongly hopes" FASB ends up being the governing body, Seidman said that any standard-setter must come to grips with the question of how much of GAAP should be altered to meet the needs of private-company stakeholders. If that doesn't happen, "any effort is doomed to fail because there will be an ongoing expectation gap," she warned.
In developing the framework, FASB's staff is looking primarily at potential differences in the disclosure needs of financial-statement users of public and private companies. "If you accept the premise that the investors in a private company have ready access to management," said Seidman, "maybe they don't need as much disclosure." The staff is also considering the unique needs of preparers of private-company financials and is mulling cost-benefit analyses in that context, according to Seidman.
Also speaking at the conference was James Kroeker, chief accountant of the Securities and Exchange Commission. "A number of areas of additional research, study, and outreach — particularly to investors — would be warranted prior to implementing any significant structural change" in financial reporting for private companies, he said.

Energy Deals Derailed by Obscure Accounting Rule

Nearly a decade after the most elaborate exercise in accounting fraud in America’s history ended in bankruptcy and prison sentences, the U.S. energy industry has yet to escape Enron’s ghost.
Now, courtesy of esoteric changes in accounting standards being implemented by the Financial Accounting Standards Board (FASB), we can add energy efficiency and clean energy to the list of casualties killed in the name of transparency.
FASB and the International Accounting Standards Board (IASB) develop financial accounting standards for beancounters. In the wake of the Enron debacle, FASB launched an effort to develop new rules for the treatment of lease transactions. In December, FASB released a joint exposure draft for these new rules, which will soon be ready for prime time.
The new guidelines would alter reporting obligations for clean energy and energy-efficiency transactions. In short, businesses would have to bring all of these lease transactions onto their balance sheets. That sucks. Still worse, in the case of energy efficiency and clean energy, the rules will not necessarily benefit the public. Ironically, it may do the opposite by distorting high-priority environmental and energy security policy objectives endorsed by legislators locally and nationally.
Currently, businesses only include capital leases as assets on their balance sheets. By contrast, in an operating lease, the lessee can use an asset without having to assume the responsibility of ownership. The new rules would require all companies to list leases transactions as assets and liabilities on their balance sheets.
This requirement will significantly deter energy-efficiency investments for developers, companies and non-profits by souring the benefits of sale leasebacks and power purchase agreements (PPAs). PPAs are currently treated as service contracts. FASB’s new rule would require PPAs to be treated as leases rather than service contracts, which would appear on a company’s balance sheet.
Although the financial mechanics of these transactions will remain unchanged, companies who pursue energy efficiency or clean energy will have heavier balance sheets and risk being perceived as having higher leverage than they otherwise would. This could make debt more expensive for companies who perform lease transactions. And that is only one penalty for those who pursue clean energy or energy efficiencies who will also likely have higher tax exposure, more extensive disclosure requirements and steeper annual accounting costs.
Simply put, in the tragic tradition of regulatory overreaction epitomized by Sarbanes-Oxley, the “proposed” FASB rule will burn the barn to roast the pig.
Ironically, unlike Enron, companies and institutions investing in clean energy and energy efficiency are not trying to bake the books. Rather, they are pursuing a perfectly legitimate institutional objective – buying electricity or reducing energy costs – and outsourcing the hassle of owning the actual system. After all, most companies and institutions are not in the energy business but dependent on it.

FASB Releases Accounting Standards Update for Repurchase Agreements

The Financial Accounting Standards Board issued Accounting Standards Update No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The Update is intended to improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.
“The Board revisited its standards on transfers and servicing to respond to concerns from financial statement users who felt the criteria for determining effective control for such transactions should be improved,” said FASB Chairman Leslie Seidman. “The new guidance improves transparency by eliminating consideration of the transferor’s ability to fulfill its contractual rights and obligations from the criteria in determining effective control.”
In a typical repo transaction, an entity transfers financial assets to a counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. Topic 860, Transfers and Servicing, prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repo agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred financial assets.
The amendments remove the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets from the assessment of effective control, as well as implementation guidance related to that criterion.
The ED is available at http://www.fasb.org/.
Since 1973, the Financial Accounting Standards Board has been the designated organization in the private sector for establishing standards of financial accounting and reporting. Those standards govern the preparation of financial reports and are officially recognized as authoritative by the Securities and Exchange Commission and the American Institute of Certified Public Accountants.

Lease Accounting Updates

FASB Releases Lease Accounting Update to Improve Reporting Troubled Debt Restructurings

The Financial Accounting Standards Board issued Accounting Standards Update No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. The update will improve financial reporting by creating greater consistency in the way GAAP is applied for various types of debt restructurings.
The update clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings.
“The increase in loan modifications caused by the recent economic downturn led investors, regulators, and practitioners to ask the Board to clarify what types of modifications should be considered troubled debt restructurings for accounting and disclosure purposes,” said FASB Chairman Leslie Seidman. “This update provides that guidance, resulting in greater consistency and transparency in the reporting of these transactions.”
For public companies, the new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. For nonpublic entities, the amendments in the update are effective for annual periods ending on or after Dec. 15, 2012, including interim periods within that annual period. Early application is permitted. The update is available at http://us.lrd.yahoo.com/_ylt=Ajc2.sZ1xDRX7CwvQjuvPN3jba9_;_ylu=X3oDMTE0azhwcmUxBHBvcwMxBHNlYwNuZXdzYXJ0Ym9keQRzbGsDd3d3ZmFzYm9yZw--/SIG=15vl06cer/**http%3A/cts.businesswire.com/ct/CT%3Fid=smartlink%26url=http%253A%252F%252Fwww.fasb.org%26esheet=6673048%26lan=en-US%26anchor=www.fasb.org%26index=1%26md5=edb557490e174acf4df4e49c6eb0aaff.
Since 1973, the Financial Accounting Standards Board has been the designated organization in the private sector for establishing standards of financial accounting and reporting. Those standards govern the preparation of financial reports and are officially recognized as authoritative by the Securities and Exchange Commission and the American Institute of Certified Public Accountants.

US Executives Unprepared for Accounting Changes

US Executives seem unprepared to deal with changes to lease accounting rules proposed by the IASB.  According to Deloitte research only 7% of respondents questions believed their company was prepared for the possible changes.  The firm questioned over 280 Executives throughout the US.  The suggested changes require more details to be included in financial reports, such as how to account for leases related to property and equipment. 

It is clearly evident that many US companies are concerned.  The compliance issues that would accompany the proposed changes would greatly impact financing, lease lengths and property strategy.  More than 40% of respondents believe the new standards would make it difficult to obtain financing in the future.

Heeding Complaints Regarding Lease Standards

Two international accounting authorities appear to be moving to scale down proposed new standards that would require landlords and tenants to account for real estate and equipment leases as assets or liabilities on their balance sheets. Many in the commercial real estate industry regard the new rules as onerous, dramatically increasing the complexity of leases for both landlords and tenants.

At a joint meeting in London of the Financial Accounting Standards Board (FASB) and its Europe-based sister group, the International Accounting Standards Board (IASB) last month, the panels directed their staffs to find an approach that would classify leases as either "finance" or "other-than-finance" contracts -- very similar to the current rules which distinguish between capital , or finance, and "operating" leases. The boards are still seeking feedback from different industries on the types of leases affected by the rules, in fact, the very definition of a lease.

The FASB/IASB released an exposure draft last August proposing that companies be required to record nearly all leases on their balance sheets as "right of use" assets, and as corresponding "future lease payment" liabilities. The panels said in a statement last summer that the proposals would greatly improve the information available to investors about the financial impact of lease contracts.

However, CRE leaders have criticized the proposed new rules, arguing that the proposals could damage both the industry and the gradual real estate market recovery. Among other problems, they said the rules could throw a wrench into capital markets by encouraging tenants to sign shorter term leases, making it more difficult for owners to achieve the longer lease commitments favored or required by lenders and investors under lending covenants.

While current rules distinguish between operating lease and capital leases, the premise of the new rules is that all leases, no matter the duration or terms, should be recorded on the balance sheets of both the lessor and lessee as an asset and liability. The rules would particularly challenge tenants, who would be forced to place a value on estimated future lease liabilities using a complicated "expected outcome" formula. Landlords also would be subject to complex new reporting rules.

More than 780 comments on the exposure draft were filed by the Dec. 15 deadline, mainly criticizing the rules as too complex, potentially costly and likely to result in unreliable financial reporting. Respondents included nearly all of the major commercial real estate players and industry trade groups.

In an interview with CoStar, Mindy Berman, managing director of capital markets for Jones Lang LaSalle, said the FASB/IASB boards appear to be making an "about face" on some of the most objectionable of the proposed rules as they begin to understand the complexity and substance of lease contracts -- and find that parts of the proposal don't reconcile with real-world leasing practices.

"They're hearing the message from the leasing community," Berman said. "It's too early to say how it's going to affect the practice of actual leasing transactions, except that it appears it's moving in the direction of being more similar to where it is today."

Under current international financial reporting standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP) standards, accounting treatment of real estate, office equipment or other leased assets differs depending on how the lease is classified. "Capital" or "finance" leases are accounted for as a sale and included on the tenant's financial statement. Contracts classified as "operating" leases, aren't recorded as assets or liabilities on a lessee's balance sheet.

"This may be the closest we've come to eliminating the distinction between capital and operating leases, but this subject has come up on a recurring basis and failed every time," noted Chris Macke, senior real estate strategist for CoStar Group. "If [the boards] are not going to materially change the classification of leases, it would be most cost-effective to maintain the current classifications."

Regardless of what the boards ultimately decide, "I would caution that we're not going back to where we were, because the new standards will still be capitalizing leases and they will no longer be off the balance sheet," Berman said. "There are going to be spotlights and scrutiny on leases that wasn't there before."

The February board actions reveal that the FASB "may be having a profound change of heart, or, at least, wants to move more slowly on any rewrite of the current lease accounting rules," John Hanley, a partner in the real estate practice of the Seattle office of law firm Davis Wright Tremaine LLP, wrote in a client paper. "The FASB and the IASB have decided to acknowledge that all leases are not necessarily the same."

At their most recent joint meeting on Wednesday (March 2) , the boards discussed accounting treatment for lessees involving non-tangible assets such as inventory, concessions and timber, but took no further action on leases of investment real estate. The boards, now meeting every two weeks, are likely to continue deliberations on a variety of issues for months, Berman said.

Also at the Wednesday meeting, the boards discussed possible effective dates and transition activities and outreach efforts for the new requirements once the boards deliberate and approve material changes to the exposure draft and issue revised rules. If the final standards are issued this year as targeted, the effective date would be about 18 months later, and likely no sooner than January 2013. Several IASB board members this week advanced an effective start date of January 2015 for all standards, including leases, while other IASB members said the start date should be based on the transition needs for each individual standard. FASB members continue to advocate a "no sooner than" effective date.

"They haven't even started [to discuss] the lessor accounting side, and that's a hornet's nest, so we think they're really trying to button down the lessee side," Berman noted, adding it's possible the boards could issue rules on the lessee side first and deal with the landlord rules separately.

"The changes so far are positive developments for the leasing community, but things can be changed and there are many more topics to tackle. Things are looking positive in the sense that the boards are incorporating feedback, and they're beginning to understand that there's a concept of leasing that's a 'use of space' as opposed to a financing decision. That's a pretty pivotal fundamental concept, and I think [the real estate industry] has broken through on that front."

In any case, Berman does not recommend that companies and service providers stop preparing for the new rules in the expectation that they may be delayed or that lease accounting treatments may remain materially unchanged.

Studies over the last year show that many companies are unprepared for accounting changes that could potentially add $500 billion in lease liabilities to corporate balance sheets. Most recently, a survey released in February by Deloitte found that just 7% of executives believe their companies are "extremely or very prepared" to comply with the new lease accounting standards.

"The state of companies' data on leasing is wholly inadequate for whatever the new lease accounting rules will be. Companies can't design the systems protocols yet, but they will still have to collect information and capitalize leases. They will still have to communicate between different disciplines within their companies."

Now is the time to start building the framework and thinking about the potential impact of various rule changes on lease transactions, she said.

"You're not going to go out and redesign your systems based on what [the board is discussing] today. But if you haven't done the fundamental investigation of how capitalization of leases will affect your balance sheet, and are not considering that as you renegotiate credit agreements, then shame on you. You're signing leases today that will extend well past the implementation date."

Great News on the Lease Accounting Front- Accounting boards move to retain lease classification

Article- International Finance News

Within the past few days, the accounting standard setters have made a series of major concessions on their proposed new rules for leasing. Following the abandonment of the plan to force lessees and lessors to account for lease renewal options (see AFI report, 17 February), the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have proposed major changes affecting lessees' profit and loss (P&L) accounting.

Further changes are proposed on accounting for variable rentals, and the rules for identifying a lease.

The most significant change from last year's exposure draft (ED) proposals is to retain some form of lease classification – not dissimilar to the current distinction between finance and operating leases – for both lessee and lessor accounting.

P&L for lessees

After initially setting out to remove the distinction between finance and operating leases, the Boards have now accepted that under the new rules there will still be essentially two types of lease.

They remain committed to forcing all leases on to the lessee's balance sheet. However, for a category of leases described in a staff report as “other-then-finance leases”, comparable with operating leases under current rules, they now propose to allow lessees to report rental expense on a straight-line basis over the lease period (under a typical contract with level rentals).

That will match the current P&L rules for operating leases. It contrasts with the front-loaded expense rules that were proposed in the ED for all leases, and are already required for finance leases.

The front loading of expense, where applicable, results from splitting the rental cost into interest and amortization. The interest is on a front loaded profile, declining in line with the outstanding balance sheet value of the liability. Amortization is normally on a straight line basis, consistent with depreciation of assets owned by the reporting entity, but the combined expense is still front loaded because of the interest profile.

That kind of accounting will not now be required for most operating leases. This represents a success for lobbying by the global leasing industry, and by lessees who would have been directly affected by the change.

The Boards' staff report prior to their latest decision cited a typical comment by one lessee respondent to the ED, energy group TransCanada: “For lessors, the Boards have proposed different accounting approaches ... based on [the extent of] retention of significant risks and rewards [from use of the asset] ... [We] believe that different accounting approaches for other than financing leases should equally apply for lessees.”

In fact that respondent, like many others making a similar point, was arguing against the capitalization of operating leases. Some others, however, including a number of US equipment lessors, felt that the front loading of expense would be a more significant problem for lessees than capitalization in itself. Their concerns now appear to have been largely met.

The staff paper also reported support for straight line lessee expense profiles among account users such as corporate analysts. These did not respond to the ED in large numbers, but were consulted later by the Boards.

The report noted: “Some [accounts] users prefer for some leases the current straight line [P&L] recognition pattern ... Most [analysts] for today's operating leases ... do not adjust the straight line  ... pattern presented in accordance with current [accounting rules]. Other users make adjustments only to reflect operating leases on the balance sheet but do not make any corresponding [P&L] adjustments.”

Drawing the line

Again in line with a staff recommendation, the Boards decided not to draw the lease-classification line entirely on residual value (RV) type considerations as under existing rules.

Instead they provisionally propose to base it on a range of criteria. In addition to RV, and closely related factors – i.e. the lease term in relation to the remaining asset life, and potential ownership transfer to the lessee - these will include:

• whether rentals are set by reference to a fixed return on the lessor's investment, or are benchmarked against market rents;
• whether the asset is specialized or customized for the lessee;
• whether the asset was available to be purchased instead of being leased;
• whether the contract contains significant embedded services not separable from the lease component;
• whether rentals are based on usage or performance of the asset.

It was agreed that these proposed criteria will be discussed in an “outreach” process with selected parties including respondents to the ED, and then brought back to the Boards for final decisions.

Lessor side implications

The implications of this decision for lessor accounting are to some extent still ambiguous. In accordance with a procedural decision last month, the Boards will not be focusing on the overall models for lessor accounting just yet. They will return to it when further progress has been made with issues affecting both lessees and lessors, and with other current convergence projects that have some interface with the leasing rules.

However, the staff report on “other-than-finance” leases assumed that the split model would apply to lessors as well as lessees. The proposed classification criteria are largely the same as those proposed in the ED for the hybrid lessor model.

The latest decisions reinforce the principle of a hybrid model for lessors, though without entirely resolving the details of the rules on either side of the finance “other-than-finance” line.

The Boards' discussion of lease classification at the latest meeting was almost entirely focused on the lessee side. However, one influential IASB member Warren McGregor indicated that his support for a continued principle of binary lease classification on the lessee side was conditional on eventual symmetry with the lessor side

It would seem likely that for contracts falling on the finance side of the new dividing line, lessors will be made subject to the partial de-recognition accounting method as proposed in the ED.

For those similar to current operating leases, however, it now seems likely that lessors would continue with current operating lease accounting rules, rather than the more complex “performance obligation” model in the ED. The staff paper envisaged that “an other-than-finance lease [would be] characterized by straight line ... income [recognition] consistent with today's ... operating lease accounting.”

Bargain purchase options

In spite of the decision to retain a binary model for lease accounting within the new standard, the Boards have not as yet changed their decision to scope out from that standard what the ED described as “in-substance purchases”. These are principally contracts with bargain purchase options (BPOs), such as hire purchase (HP) deals in the UK.

The Boards are due to consider feedback from the ED on this and other scoping issues at a later date. BPOs are accounted for as finance leases under current rules. However, some Board members at the latest meeting said that they felt that BPO contracts should remain scoped out, to be covered instead by the separate current IASB/ FASB convergence standard on Revenue Recognition.

If that remains the decision, the intended substantive accounting for BPO contracts by lessees and lessors would remain similar to that for finance leases. However, these rules would be found in a separate standard, probably with no guidance specific to the contracts.

Contingent rentals

Again following a staff recommendation, and in response to critical reactions from respondents, the Boards have tentatively agreed to simplify the ED proposals on accounting for contingent rentals. This includes rental variations based on asset usage volume, such as mileage payments in vehicle leases.

The ED proposed that where leases have variable rentals, lessees should account for them on a probability-weighted expected outcome basis. Lessors would have been required to do the same for their lease receivables, though only where the variations could be reliably estimated.

However, the Boards now propose that the initial recognition of contingent rentals should take account of only indexed-based variations, such as those based on market interest rates or a price index, plus any other contingent rentals that are “reasonably certain” to be incurred. This is subject to further outreach consultations to ensure that the “reasonably certain” criteria will be workable in practice.

The Boards also agreed that the initial measurement of index-linked rentals should be based on prevailing rates at the inception of the lease. This replaces an ED proposal to use forward rates where readily available.

The rules for reassessing contingent rentals at subsequent reporting dates will be considered by the Boards later.

Identifying a lease

The Boards have now made some tentative decisions, subject to outreach consultations, on the question of how to identify the existence of a possible lease embedded within a service contract. This follows consideration of the issue at non-decision-taking meetings in the preceding weeks.

This aspect involves a variety of contract types, some more relevant to mainstream equipment leasing than others. The relevant guidance proposed in the ED was based largely on existing rules.

Following comments in response, however, the Boards now accepted that the guidance needs to go further now that operating leases are going on to lessees' balance sheets. The difference between lease and service accounting becomes more critical as a result.

One issue raised by the Boards' staff was whether a contract, in order to be identified as a lease, should have to involve the availability of a uniquely identifiable asset, or just an asset of a particular specification. A small majority of Board members preferred the potentially broader definition (i.e. an asset of a particular specification).

However, it was agreed that both alternatives should be “field tested” in outreach. The consultations will focus on whether the broader definition would be reasonably easy to apply, and whether the narrower one would create structuring opportunities to avoid lease accounting.

The Boards decided to add a new provision, so as to exclude identifying a lease where an asset is incidental to the provision of a service. This would apply where the asset is specified by the service supplier as a mechanism for providing a contractual service; or alternatively where the asset component of the contract is insignificant compared with the service component in terms of benefit to the customer.

Members considered whether both of those conditions should need to be satisfied in order to avoid having to recognize a lease. However, they decided that one or the other should alone be sufficient.

The Boards also decided that guidance should be given on the possible recognition of an embedded lease of part of a larger asset not solely used by the relevant customer. They decided to go for outreach consultation on two alternative formulations. Under one alternative, only a physically distinct portion of a larger asset would give rise to the identification of a lease (if made available for the customer's use within a service contract). The only example to be given in guidance would be a real estate asset (i.e. a floor within a building).

Under the other alternative, preferred at this stage by a majority of the Boards' members, lease recognition could extend to a physically non-distinct part of an asset, such as part of the capacity of a fibre optic data cable.

Finally, the Boards considered criteria related to control of an asset specified in a contract. The starting point for this (although it was accepted that changes were needed) was the draft ED guidance based on existing rules. Essentially that defines control as either:

• Having the ability to operate or control physical access to the asset as well as the right to obtain some of its output or utility; or
• Having the right to obtain “all but an insignificant amount” of the output or utility, if the pricing is such that the customer is paying for the right to use the asset, rather than for the actual extent of use or for the output.

Various alternative definitions of control were considered. The Boards decided to field-test two possible variations through further outreach.

Their preferred version would somewhat reduce the scope of contracts that would fall to be recognized as leases, by aligning the rules with a definition of control in the draft Revenue Recognition standard. This would specify that the customer would obtain control of the asset where it has the right to obtain “substantially all of the potential cash flows from that asset”.

In this variant the customer would not recognize a lease unless it had both the defined right to the benefits of the asset and the ability to direct its use. Some “take or pay” power supply contracts might be excluded.

As an alternative, another variation that would be intended to have broadly the same scope as existing rules, but with a simplified form of words compared with the ED version, will also be filed-tested.

Contracts that clearly include both lease and service elements, but where there may be issues in separating the two components for accounting purposes, have not yet been reconsidered by the Boards since the ED consultation. That aspect will be dealt with later.

Accounting Standards Boards of Japan, U.S. Consider Global Convergence

Representatives of the Accounting Standards Board of Japan (ASBJ) and the Financial Accounting Standards Board (FASB) met Feb. 7 and Feb. 8 in Norwalk, Conn. This meeting was the 10th in a series of discussions between the ASBJ and the FASB designed to enhance dialogue between the two boards in their shared pursuit of global convergence of accounting standards.

In November 2010, the FASB and the International Accounting Standards Board (IASB) issued a joint statement, Progress Report on Commitment to Convergence of Accounting Standards and a Single Set of High Quality Global Accounting Standards, which affirmed their priority projects. The decisions connected with the use of IFRSs are expected to be made during 2011 for the United States and in or around 2012 for Japan. With those decisions in sight, both the ASBJ and the FASB are vigorously conducting their respective convergence programs with the IASB.

“As the decisions connected with the use of IFRSs in both countries approach, it is extremely meaningful to exchange views with the FASB regarding financial instruments, revenue recognition, leases, and the measurement of liabilities, most of which are high priority MOU projects between the FASB and the IASB,” said Ikuo Nishikawa, chairman of the ASBJ. “I am pleased that we were able to affirm our continuing relationship between the ASBJ and the FASB under the leadership of newly appointed Chairman, Ms. Leslie Seidman. The ASBJ will continue to contribute to the development of high-quality, global accounting standards.”

At this meeting, the ASBJ and the FASB updated each other with the recent developments in their respective convergence projects with the IASB. They exchanged views on the following projects:

• Financial instruments (based on the credit impairment model for financial assets recently deliberated by the FASB and the IASB and the Exposure Draft on Hedge Accounting issued by the IASB in December 2010)
• Revenue recognition (based on the FASB and the IASB’s recent redeliberations with respect to the Exposure Draft on Revenue Recognition)
• Leases (based on the FASB and the IASB’s recent redeliberations with respect to the Exposure Draft on Leases)

The ASBJ and the FASB also exchanged views on issues related to reflecting the current interest rate in the measurement of liabilities, as a cross-cutting issue.

“The FASB iscommitted to working cooperatively with the ASBJ on important issues related to the international convergence of accounting standards,” said Chairman of the FASB Leslie Seidman. “Our dialogue on major joint projects with the IASB, and our shared interest in international convergence, are important to ensuring the future of high-quality financial reporting in both Japan and the United States.”

The next joint meeting is planned in the summer of 2011 in Tokyo, Japan.

The Accounting Standards Board of Japan (ASBJ) was established in July 2001 as a private-sector organization. Accounting standards developed by the ASBJ are to be authorized by the Financial Services Agency as part of generally accepted accounting principles. The ASBJ develops accounting standards and implementation guidance that appropriately reflect the environment in which business enterprises operate. The ASBJ also communicates with corresponding organizations abroad and contributes to the development of global accounting standards. For more information about the ASBJ, visit its website at https://www.asb.or.jp/asb/top_e.do.

Since 1973, the U.S. Financial Accounting Standards Board (FASB) has been the designated organization in the private sector for establishing standards of financial accounting and reporting in the United States. Those standards govern the preparation of financial reports and are officially recognized as authoritative by the Securities and Exchange Commission and the American Institute of Certified Public Accountants. Such standards are essential to the efficient functioning of the economy because investors, creditors, auditors, and others rely on credible, transparent, and comparable financial information. For more information about the FASB, visit its website at http://www.fasb.org/.

Keep up-to-date on all the accounting standard news at Mazuma Capital

Lease accounting: boards now take stock of responses

In two meetings over recent weeks, the accounting standard setters have started to consider how to finalize the new leasing standard. The Boards, (International Accounting Standards Board (IASB) and the US Financial  Accounting Standards Board (FASB), received reports from their staffs on the pattern of response to the exposure draft (ED) in the recent consultation, and subsequent meetings with stakeholders. 

For additional information Visit http://mazumacapital.com

Paper Asks for Input on Hedge Accounting -FASB Discussion

The Financial Accounting Standards Board issued a Discussion Paper to solicit input on how to improve, simplify, and converge the financial reporting requirements for hedging activities.

In May 2010, the FASB proposed its revisions to improve and simplify standards for financial reporting of financial instruments, including hedge accounting guidance, in its proposed Accounting Standards Update, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities—Financial Instruments (Topic 825) and Derivatives and Hedging (Topic 815). In December 2010, as part of its project to improve the accounting for financial instruments, the IASB issued its Exposure Draft, Hedge Accounting, which seeks to align hedge accounting more closely with risk management while addressing inconsistencies and weaknesses in the existing hedge accounting model.

Since 1973, the Financial Accounting Standards Board has been the designated organization in the private sector for establishing standards of financial accounting and reporting. Those standards govern the preparation of financial reports and are officially recognized as authoritative by the Securities and Exchange Commission and the American Institute of Certified Public Accountants. Such standards are essential to the efficient functioning of the economy because investors, creditors, auditors, and others rely on credible, transparent, and comparable financial information.

Read article (2/10) The Discussion Paper is available at www.fasb.org. Written comments on the documents should be submitted by April 25. For additional information Visit http://mazumacapital.com

US businesses push back on lease accounting change

Here at Mazuma Capital Corp we have been talking a lot about the new lease accounting changes scheduled to be put into effect in 2011.  As a lease originator the big question is how detrimental will this change be on an already wounded economy and struggling industry?  Changes to off balance sheet accounting have been a topic of discussion for quite sometime, but many feel this is the wrong time to implement. The change could ultimately triple debt limits in loan agreements for some companies.

We hear that things are looking up and companies are beginning to hire, yet those in the trenches feel otherwise.  So what will happen to all of the U.S. businesses who currently have significant leases off the books? Is it a possibility for profitable companies to tank overnight due to this change?

It seems that business groups are gearing up to delay proposed accounting rules that would bring hundreds of billions of dollars in leases onto corporate balance sheets, even as backers say the revisions will give investors crucial information. Many companies - with the help of the leasing industry - have avoided putting leases on the books by structuring them to fall below the 90 percent threshold. Such leases are considered operating leases and only require a rental expense on the income statement.

At issue are rules proposed by U.S. and international standard setters. The changes are meant to address complaints that investors are not getting a complete picture of companies' debt because massive lease obligations are relegated to footnotes in financial statements. The changes could cause companies to avoid leases entirely.  The changes will be more complex, forcing many businesses to do things that hinder growth and development.

The lease accounting changes will take a few years to fully take effect, but there will be causalities. What will this mean for the leasing industry that have assisted in growth and profitability for U.S. businesses? The S & P reports that there is at least $549 Billion in lease liabilities lurking off balance sheets. That's $549 Billion that will be off the books one day and on the books the next day.  Here is a little information on what we can expect from businesses that currently use leases from Delta Airlines to McDonald’s.

Financial statements would change significantly at airlines, which lease many of their aircraft rather than owning them. Delta Air Lines, which had about $17 billion in long-term debt at year-end 2009, would see that number jump by roughly $8 billion.

McDonald's Corp, which leases about 14,000 restaurant locations and is a lessor for another 19,000, may have to spend as much as $100 million because of technology and staff resources required for the accounting change, the company said in a letter to rule-makers last month.

The new standards are a joint project of the Financial Accounting Standards Board, which sets U.S. accounting rules, and the International Accounting Standards Board, which sets international standards. The boards are holding public meetings through Jan. 6 before crafting a final rule.

Sources:

S& P

Reuters Business

Companies Brace for Powerful Impact of Lease Accounting Changes

Proposed new accounting standards have been drafted in order to push lease liabilities back onto corporate balance sheets. Such a change would represent a major shift for companies that have typically favored the off-balance-sheet treatment of operating leases, and it could have a significant impact on corporate decisions to lease or purchase real estate in the future.

The proposed guidelines are a joint initiative by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board to create a uniform global standard and greater corporate transparency in lease accounting procedures. The most recent draft would establish one method of accounting that requires firms to recognize all lease liabilities and assets on their corporate financial statements.

Another key component is that companies would be required to record the lease value or rent commitment over the entire lease term, including renewal options. Although the intent is to stop off-balance-sheet activity, the changes would add significant weight to corporate balance sheets.

For example, a firm that pays $1 million per year in rent for its corporate headquarters would quickly see its liability multiply depending on whether it has a five-year or 15-year lease. Companies would appear more highly leveraged, which could affect factors such as corporate credit and existing debt covenants.

Although FASB cites data that values leasing activity at $640 billion in 2008, other industry sources estimate that current volume as high as $1.3 trillion in operating leases for U.S. firms alone. Once the guidelines go into effect, which many in the industry believe will occur in 2013, both new and existing leases would be immediately affected.

One fear is that the new accounting practices could deter companies from signing long-term leases, or encourage firms to own rather than lease facilities. Both of those factors could be a detriment to the sale-leaseback and net-lease finance niche where leases typically extend 15 years and beyond.

Sale-leaseback transactions have accounted for $24.8 billion, or slightly more than 50%, of the $46.6 billion in single-tenant sales globally over the past 12 months from June 2009 through June 30, 2010, according to Bloomberg Business.

Proposed Accounting Changes...What is next for businesses?

The big question looming over the proposed accounting changes, is how will big business deal with the disappearance of operating leases? 
I'm not an expert, however I can tell you a few things for certain. First, most companies lessors and lessees are hiring accountants with heavy international experience in real estate. Second, the financial accounting impact is not going to result in competitive disadvantage since all companies must comply. Third, there will be differences in the overall adjustments experienced depending on how mature the leases are with respect to tenant occupying the space.

The valuation topic will pick up more steam and perhaps the number of options to renew included in the original lease will be reduced, basically the leases may be written differently. Overall there will be more transparency as to financing strategy in companies who have chosen to lease all locations rather than invest in capital assets - the wirelesss telecom industry generally leases all tower locations or builds to suit on leased land. There are many discussion brewing within this industry regarding how to move froward with new tower locations.

Most important at this moment is to prepare the shareholders for drastic changes in reported numbers. Applying the proposed changes will mean putting most of your leased assets on balance sheet, which will result in changes of businesses financial performance indicators, such as ROI. It will also affect the structure of earnings statement, as the expenses will be moving lower in your income statement. It is also important that some bank covenants may be affected. The preparation for such changes requires careful management of expectations, from both, shareholders and banks.

Bottom line, business will adjust and continue on, still exercising the option to pay cash or lease. The leasing industry will continue to grow and evolve with the changes likely to be put into effect (Mid- 2011).  New products and offerings will still add value for businesses and will continue to be a great option to keep operating cash clear, as well