Addressing an industry gathering in Washington, D.C., Carlton Tartar, of the SEC’s Office of the Chief Accountant, referred to the Financial Accounting Standards Board’s current project on Accounting for Leases as a ‘fundamental sea-change’ in accounting. Tartar, an associate chief accountant at the SEC, was speaking at the Accounting Workshop at the conclusion of the Practicing Law Institute’s SEC Speaks Conference on February 21-22, 2014.
Leases Among the Final Four – Now Three – Convergence Projects
FASB’s project on Lease accounting (along with Financial Instruments and Revenue Recognition), is one of the three remaining “convergence” projects under the bilateral convergence program originally established in 2002 between FASB and the International Accounting Standards Board. The IASB has announced a move to a more ‘multilateral’ focused model. FASB has spoken of increased focus on U.S. GAAP, while continuing to support the IASB by participating on IASB’s Accounting Standards Advisory Forum -- and at the same time moving to its own ‘decentralized’ approach to convergence.
Regarding a potential fourth remaining “convergence” project - on Insurance Contracts - FASB recently decided to focus its efforts “on making targeted improvements to existing U.S. GAAP.”
FASB’s Lease Project: A Fundamental Sea-Change in Accounting
According to my notes from PLI’s SEC Speaks conference, here’s what Tartar told the Accounting Workshop attendees about FASB’s Leases project:
- The Lease accounting project has been evolving, and something is going to happen. A fundamental sea-change [in lease accounting] will put lease assets on the balance sheet.
- Most leases are not put on lessee’s balance sheets, even if substantially the same as if financed.
- Under current GAAP, there are four tests, and if you trigger any one of these, you have to put the asset on the balance sheet. The tests include:
- Bargain purchase option
- Transfer of title
- Payments equal to or greater than 90 percent of fair value of the asset
- Lease term equal to or greater than 75 percent of useful life of the asset
- The reverse can also be true:
- i.e., nonperformance considerations
- Basically, the lease model under current GAAP is very form-driven (i.e. form over substance).
- That’s why credit rating agencies have done their own modeling [when leases are present] for years.
- Under FASB’s proposal, the basic model is:
- The lessor is conveying a Right to Use under the lease contract
- There are discounted lease payments
- There is a Right-of-Use Asset for any lease with a maximum potential lease term greater than 12 months
- In FASB’s first Exposure Draft, Lease Expense would have been accelerated, with higher interest expense in earlier periods – i.e. a front-loaded expense.
- Preparers complained about that idea not [representing] economics [by implying] diminished utility
- The Revised Exposure Draft in 2013 included a classification test – as to whether you have accelerated expense as originally proposed;
- All property leases will have straight-line expense, and
- All other leases – such as equipment leases, and so forth, will have accelerated expense.
- It seems highly likely at some level, we will have lease capitalization, where we have not had that before.
Pausing briefly in his remarks, Tartar continued:
- What does this mean for attorneys?
- If your client has leases that may go on the balance sheet under the project when finalized, it may mean an increase in liabilities, and there may be a need to renegotiate:
- debt covenants, and
- reference points in debt contracts such as EBITDA
Operationally, Tartar added:
- Companies don’t really do a lot of tracking [related to leases]
- The [leases project] may have a significant impact on all public companies, especially industries, for example, like retailers and airlines, among others.
Leases Standard Will Provide Another Internal Control ‘Moment’ – Minton
Jeffrey Minton, chief counsel in the SEC’s Office of the Chief Accountant, added that FASB’s Leases project may provide “another Internal Control over Financial Reporting ‘moment’ in which to figure out what controls and processes you’ll need to have in place.”
Detailed comments from staff of the SEC’s Office of the Chief Accountant on the topic of Internal Control over Financial Reporting, including implementation of updated guidance issued by the Committee of Organizations of the Treadway Commission (COSO), can be found in Internal Control Reporting an Area of Focus at SEC. Information about PLI’s SEC Speaks Conference can be found at www.pli.edu .
See also our prior posts from the SEC Speaks Conference: Glassman Suggests SEC Give Co’s More XBRL Data, and Will Audit Committees Be Next Target of SEC’s Operation Broken Gate?