When will the leases project take off, and where will it land?
27 April 2012
The scenario is all too common: you get on a plane anticipating that you will take off on time, only to discover that you’re sitting on the runway, delayed indefinitely. Could this be the fate of the frequently quoted aeroplane that Sir David Tweedie fought so hard to get onto the balance sheet as part of the proposed new leasing standard? I hope not.
The IASB and FASB have made significant progress on several key redeliberation issues; I broadly support the boards' revised position on lease term, variable lease payments and definition of a lease. These should significantly improve the operationality and reduce the complexity and costs of applying the new standard without significantly reducing the benefits. However, the boards have been debating at length without yet reaching a consensus on two key remaining issues: subsequent expense recognition for lessees, and a cohesive model for lessor accounting. It is important for the boards to agree a way forward if the whole project is not to be delayed indefinitely.
Constituents have been vocal that the impact of the proposed front-loading of expense is positively unhelpful to those trying to forecast, especially if cash flows are actually back-loaded. But the boards could not agree on how to resolve this. It would take an entire blog to explain the approaches favoured by the IASB and FASB (see Straightaway 80 – FASB/IASB leasing redeliberations]. But, at a simplistic level, both approaches at the extremes would result in the same expense recognition − that is, front-end loading of expenses for some leases and straight-line expense recognition for others. The key difference is that the IASB’s preferred approach would graduate between these extremes, whereas the FASB would use a ‘bright-line’ to make a cut between either straight-line or front-loaded expense profiles.
It is easy to understand why the IASB’s preferred approach could be attractive in theory, but it might be overly complex. So the FASB’s preferred approach would appear to better meet the request for a workable standard. Although a bright-line would still be retained, it is based on a risk-and-rewards concept that is generally well understood and known to be operational. It is also worth remembering that under both approaches, all leases will be on-balance-sheet. The boards have instructed the staff to gather feedback on whether preparers can operationally achieve the IASB’s preferred approach, but determining the operationality is just one piece in the puzzle. It is equally important to address the cost/benefit question. Does the graduated scale and conceptual underpinning of the IASB’s preferred approach give the user more relevant and faithful information compared to the use of a bright-line based on current IAS 17 indicators? If so, does this increased benefit outweigh the additional cost and complexity associated with the IASB’s preferred approach?
Consider also the implications of the above matters for lessor accounting. Should the IASB’s approach for lessees be chosen, it would undoubtedly raise questions about whether lessors could approach their investment property leases differently from other leases (as currently proposed). So the debate on lessee income statement recognition has implications for lessors as well as lessees. I would prefer the boards look at lessor and lessee accounting at the same time but do not believe the proposed hybrid approach is a sufficiently significant improvement to current guidance to justify the substantial cost of change. I would therefore recommend lessors to continue applying the existing lease guidance (perhaps with some amendments to matters such as lease term, variable lease payments and definition of a lease) until the boards are able to develop a lessor approach that is consistent with both lessee accounting and accounting for leases/licences of intangible assets.
Key to the success or failure of the leases project is the participation of users and preparers in the consultation process that will allow the boards to determine the cost and benefits of the proposed approaches. Armed with that information, the boards must remain focused on meeting the primary objective of the project − namely, the need to get all leases on-balance-sheet while proposing a workable standard. If they are able to do this and reach consensus, there is still a chance that the project’s delay will only be temporary and that eventually the aeroplane will take off, and land on a lessee’s balance sheet.