How Managers Do Love the Leasing ED: Let Me Count the Ways
An excerpt from a WSJ blog:
“Outgoing FASB Chairman Leslie Seidman has had plenty of time to tackle long-standing questions about whether accounting principles are more desirable than specific accounting rules, writes Emily Chasan. The debate over whether detailed rules and bright-line exceptions are more or less useful than broad principles that require management judgment has dominated her past 1o years on the board. “I think it’s undeniable that we Americans like our rules,” Ms. Seidman said … in her final public speech as chairman of the U.S. accounting rule maker.” [emphasis added]
I guess that settles it. Now we know for certain why FASB standards have gone from bad worse. But even if Ms. Seidman is correct about a preference for rules, the FASB has come up way short of the mark. The three super major projects she leaves for others to complete after her second five-year term soon comes to an end are the most direct evidence that “loopholes” are the most apt descriptor of the Board’s output: loan impairment, revenue recognition and leases.
Focusing on lease accounting by lessees should be enough to make the point; and I want to focus on that since I just finished preparing my presentation on the most recent ED for my upcoming “FASB Update” course in Chicago. There may be some straightforwardly applicable rules in that ED, but all except for the requirement to recognize some small portion of the full lease liability are not nearly as consequential as the smorgasbord of loopholes set out for managers to manipulate their earnings — without waking up their auditors or getting a call from an SEC investigator. Some are carryovers from existing U.S. GAAP, but if any of the rest were to make you think they were concocted in the IASB’s central sausage factory, I wouldn’t argue with you.
Here’s the best of the wurst:
The lease smoothie—For assets that meet the definition of “property” (a judgment call all by itself), subjective criteria will determine whether management can choose to recognize lease expense straight-line — as opposed to a pattern approximating the actual economics. The boards are leaving it to management’s judgment to determine if: (1) the lease term is not for a “major” part of the remaining “economic life” of the asset; or (2) whether the present value of the lease payments is not a “significant” part of the value of the asset; or (3) whether there is a “significant economic incentive” to exercise a purchase option; or (4) that land and/or building is the “primary asset” under contract.
Hide-the lease-payment trick #1—The lease payments to be recognized as an asset and corresponding liability generally are limited to the payments in the contract that are fixed. However, judgment is required to determine if payments that are contingent on a level of activity (e.g., retail sales in leased store space) are in fact “disguised” as fixed lease payments. In other words, management is supposed to say, “HA! I just caught myself disguising fixed lease payments as variable payments. I had better include those in the asset and liability!” (Gimme a break.)
Hide-the-lease-payment trick #2—Judgment (are we getting tired of that word yet?) is required to treat “expected” (not defined—what a surprise) amounts to be paid under residual value guarantees as lease payments to be capitalized.
Who said buy-borrow?—Options to purchase the asset need to be evaluated for in-substance lease payments. (Another “HA! I caught myself doing a bad thing.”)
Mix and match—Judgment is required to determine if part of the cash flows are not actually lease payments; and more judgment is required to estimate how much should be accounted for according to some other standard. It could even get to the point that a lessee would have to estimate the fair value—i.e., a sales price—for services that it would never purchase separately and arbitrarily carve them out of the cash payments to the lessor.
My all-time favorite—When to take account of renewal or termination options when estimating the lease term is based on whether there is a “significant economic incentive” to renew or terminate. For that, we have the old IASB chestnut of “management intent” as one of the factors to consider.
Don’t wake me from my dreams—Judgement is required to determine that the factors originally used to account for a lease have changed significantly enough to make reassessment appropriate.
There is still more, but that should be more than enough to illustrate that the FASB’s latest gift to investors is far from a compendium of “rules.” More than a decade ago, a much more attuned SEC issued a clarion call to accounting standards setters to finally end operating lease treatment; for it was seen then, as now, as the most pernicious form of off-balance sheet financing. This ED is nothing more than one last-ditch effort to take what could have easily been an extremely modest proposal for lease capitalization off life support.
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I can’t decide whether Ms. Seidman was being disingenuous, or if after all this time she still hasn’t the foggiest notion what investors want. Surely, she and her fellow board members must realize by now that “Americans,” or investors anywhere else in the world, don’t care a wit about the admixture of rules and unspecified “principles” that comprise accounting standards.
For the FASB to survive, they will eventually have to come to grips with the fact that they don’t need “constituent” roundtables, or comment letters, or open meetings to figure out which way lies progress: Investors want financial statements that report numbers that are capable of being described and understood; and that are immune from management manipulation.
How could they want anything else?