Consensus for Leases is Difficult to Find
I’m going into my last week as a FASB Research Fellow. The past year has been very educational for me as I’ve observed up close the process that the Board goes through in promulgating standards. I’ve developed a better understanding as to why some projects proceed at a painstakingly slow pace. I’ve also gained a greater respect for the amount of thought and effort that goes into the deliberation process. The Board members and staff are very smart people, all with impressive backgrounds. It’s easy to criticize from afar the process and decisions made by the Board based on one’s own perspective, but my opinion is that most critics don’t fully appreciate the difficulty in reconciling the many contrasting views voiced by various constituents (including other standards setting bodies), and promulgating standards that accurately reflect the underlying economics and will be generally accepted.
Leases is one of those projects that is currently floundering, and if I was back in my academic office, I would certainly be wondering, “What is the Board thinking?” The original proposed standard was exposed back in 2010 and required that all leases be capitalized and the liability accounted for using the effective interest method. That view is easy for me to understand and support. Over two years later, the Board and staff have conducted extensive outreach with various constituents, and they still appear to be very far away from a new standard. Depending on who they talk to, the Board and staff are getting very different messages. Of course, this happens on many other projects too, so why are leases causing so much consternation?
I think the reason is due to the several unique features with leases. First, it is sometimes difficult to distinguish between a lease and a contracted service. The FAF contracts with an outside company for copying and other services. The company brought several pieces of equipment into our building and when we need copying done, we simply hand in the originals to somebody here. Most people would say this is a service. But, since all the equipment was brought into our building, how different is this really from leasing the equipment? In our Roundtable this week, Cullen Walsh brought up another good example with respect to leasing servers versus contracting for a “cloud” service.
The other major issue is that constituents can sometimes convincingly argue that their leases are more of a periodic rental expense (much of which are for services) instead of a purchase of an asset with a financing component. Real estate is the best example. Companies often will rent space within a building for a periodic fee and part of the fee is for daily services, such as, security, parking access, cleaning, insurance, etc. The company has no obligation beyond the contracted term to stay in the building and when they leave, the value of the building is often the same or maybe even greater than the value of the beginning of the lease. Thus, no asset has been “used up.” Fundamentally, this seems like a different type of lease relative to leasing equipment. This has led the Board to tentatively decide on a two-model approach for leases, which was described in our Roundtable.
However, after all the deliberations and consideration of numerous models, the current position doesn’t seem to be pleasing anybody. The Board met with ITAC (their user-group advisory committee) this week to discuss various topics, including leases. The views from this group on the tentative decisions were decidedly mixed. Perhaps more telling is that even among users, there were diverse opinions as to how to account for leases. Some even expressed an opinion that all leases should be accounted for as rent expense. Others believed that the original exposure draft on leases should not be changed. Still others believed that leases are simply a series of forward contracts and should be accounted for consistent with how we account for other forward contracts. Hardly any support was expressed for the tentative two-model approach.
One of the reasons the leases project was placed on the Board agenda was based on feedback from users that they adjusted financial statements based on information in the leasing footnote. This feedback is consistent with evidence from academic research suggesting that investors appear to adjust financial statements as if operating leases were capitalized. The FASB wants to provide better information to users consistent with how they were using lease information under FAS 13. But they need to be careful that users will not continue to adjust whatever is required by the new standard because in that case, the information would not be any better than the current state (and therefore, the benefits would not justify the costs of implementing a new standard).