Has the FASB Approached Lease Accounting as an “Independent” Standard Setter?

The FASB is now 40 years old, and its lease accounting standards are about the same age.  Some would say that SFAS 13 was obsolete when issued, but it only became a front-burner topic for the FASB about a decade ago — after the SEC officially declared it broken in 2003.  At the time, the SEC also forewarned the FASB about the resistance it would encounter, should it attempt to intervene in the feeding frenzy that SFAS 13 had wrought:

“[T]he current accounting guidance, which is criticized by many, would likely be held in much higher regard were it being applied to the lease arrangements that existed when it was debated and created. Changes in lease terms in response to the accounting guidance have caused undue focus on the weaknesses of the guidance. The fact that lease structuring based on the accounting guidance has become so prevalent will likely mean that there will be strong resistance to significant changes to the leasing guidance, both from preparers who have become accustomed to designing leases that achieve various reporting goals, and from other parties that assist those preparers.” [emphasis added]

If one accepts the SEC’s perspective, which I do, then one would have to acknowledge that the FASB failed to protect investors when they promulgated SFAS 13.  Knowingly or not, the bulk of what the FASB did was to create a game for preparers and providers of “financial services” to play against investor interests.

The SEC’s observation also served to forewarn the latter-day FASB that it would have a tough job convincing the executives and “consultants”, who have grown wealthy from playing the lease accounting game, that improved standards were in order.  I’m sure this was obvious to all concerned, so a bit of frank honesty about the political forces arrayed against them might have been appreciated.  Instead, we have recently received this platitude from new FASB Chairman Russell Golden in his maiden speech:

“[FASB independence] is a privilege to be earned — every day — through all that we undertake.”

It would seem that the SEC’s statement was a clarion call for the FASB to take a step back from the clamor of special interests and to ask questions like: what should lease accounting entail?  What does the conceptual framework, or academia have to say about the problem?

Unfortunately, I don’t think “independence” will be the first word that comes to most people’s mind if asked to characterize the FASB’s struggles to reform lease accounting.  “Trial and error” would be more like it; an iterative search for new rules to the same old game so a sufficient number of stakeholders might still agree to play along without making too big a fuss.  As of the latest iteration, they are hoping that a requirement to capitalize leases at some contrived amount will mollify investor interests, while still retaining a preparer’s ability to smooth earnings and conflate operating costs with interest expense.  If the IASB can get away with it, why can’t the FASB join the race to the bottom?

Against this backdrop, it could hardly be said that the FASB has “earned” independence, much less respect for its “due process.”  For if it had, then it wouldn’t have been slapped so hard up the side of the head by its own Investor Advisory Committee.

Essentially, the IAC informed the FASB  that it would not support the latest lease accounting proposal.  Capitalization of leases at a contrived amount would not constitute progress; and if this was the best the FASB could come up with, then it shouldn’t bother changing the accounting for leases. All that a new standard would accomplish would be to impose unnecessary transition costs and to upset the status quo.  Instead, the IAC stated, the FASB should set forth a system of detailed disclosures for analysts to use in making their own calculations and adjustments to the financial statements  — analyst-by-analyst and company-by-company.

Picking up the Pieces

In addition to reading media reports, I listened to the webcast of the meeting before writing this blog.  It wasn’t easy, but not because the discussion was not enlightening: If Mr. Golden is interested in improving FASB processes, I would ask that he start by producing videos of reasonable quality to record the public proceedings.

That aside, I did learn two important things about the schism between the two groups.  First, communications between the IAC and the FASB taking place over the years must have been extremely poor, and possibly very strained.  If the FASB had ever adequately communicated its objectives and rationale for a new leasing standard, they must have fallen on deaf or unsympathetic ears years ago.  I do know that the IAC had begun weighing in on lease accounting at least four years ago, but nothing seems to have happened since to sway, or at least educate, the IAC members.

Second, and relatedly, I’m disappointed that the IAC conveyed its message in a very ad hoc and disjointed manner.  A lot of their comments must have seemed to the FASB members to have come out of left field.  The IAC paid no heed to any traditional (or practical) constraints on accounting information, and it took the unconstructive view that leases are merely financial anomalies, with each contract as unique as a snowflake.  Wow.

If modern finance has taught us anything, it is that financial contracts can be viewed from the perspective of a finite number of basic building blocks, which are straightforwardly specified and subject to reliable pricing models. If we can value the building blocks, we can value the building.  (To the best of my knowledge, at least one IAC member (Dane Mott) has grasped this concept, but he may have been alone. He wrote a detailed comment letter explaining his views, which you can read here.)

So, what next?  The FASB chair appoints the members of the IAC, and that hand-picked voice of investors has repudiated the latest iteration, and hasn’t been supportive at any point of the FASB’s approach.

If Mr. Golden is going to walk the talk on independence, this is his acid test: he has no choice other than to take a fresh look at lease accounting.