Today (July 19, 2012), the FASB and IASB held a question and answer webcast with constituents concerning the decisions on lease accounting reached at the June 12 meeting. Recall that at the June 12 meeting, the boards settled on two different approaches: real property (land and buildings) would have straight-line expense on the income statement, while the expense for vehicles and equipment would be front-loaded (higher total expense in the earlier part of the lease). See my summary of the two approaches here and here. The following is a summary of today’s webcast.
There were numerous questions concerning the boards reasoning by suggesting two different approaches for real property (straight-line expense, depreciation only) and equipment (front-loaded expense, depreciation and interest expense). The presenters responded by giving an example concerning rental space at a mall leased for 3 years. At the end of the lease, because the reduction in value of the mall as a result of the vendor’s 3 year lease is insignificant, that vendor is only paying for a right to use that space, and not “acquiring” it. Because the vendor is not acquiring the asset, there is no “financing” expense, and the lease expense on the vendor’s income statement should be even in each of the 3 years (straight line expense, depreciation only). On the other hand, consider a 10 year lease on an airplane. After 10 years the airplane would have diminished in value (unlike the mall), so the vendor is paying for the right to use the airplane, and paying for financing of the piece of airplane consumed. As such, there would be higher total expense at the beginning of the lease (front-loading) because there will be depreciation and interest expense components.
Some individuals asked why the boards decided not to use the risk/reward guidelines as a distinguishing factor. They felt like if the risks and rewards of ownership are transferred, then the lease should be treated as having a financing component, and thus front-loaded. If risks/rewards are not transferred, then expense would be straight-line. The boards countered that the risk/reward guidelines focused primarily on acquisition of the entire asset, as such if the boards had followed those guidelines they would exclude those leases where the user acquires “more than an insignificant” portion but less than the entire asset, which they capture under the proposed system.
Constituents asked if the boards would define what constitutes “more than an insignificant” portion of the asset. The presenters responded that the boards were unlikely to define insignificant using numbers, but they would give numerous examples. They acknowledged that judgment would have to be used in some instances, for instance a building lease with a 30 year term, or a vehicle lease with a 5 year term. They however stated that their expectation is that in most cases the correct approach would be pretty clear.
Constituents asked if non-public companies would have the same effective date as public companies, and the presenters responded that while the effective date has not been determined yet, a provision might be made for non-public companies to adopt the guidelines at a later date.
The presenters also stated that the expectation is that early adoption will be permitted, and while the expected transition is the retrospective approach, it is not going to be fully retrospective.