COMMENT LETTER GUIDANCE

FASB/IASB LEASE ACCOUNTING PROJECT

The FASB issued the second Leases Exposure Draft (ED)on 5/16/13. While TRALA has submitted a comment letter on behalf of the industry, you are encouraged to submit your own letter as well. The deadline for comment letters is 9/13/13.

  • The most recent Exposure Draft can be found at this link: An executive summary of the exposure draft is presented below
  • Already-submitted comment letters can be read at – the Comment letter Tab. This will give you ideas for your own comment letters and you can see the format that others have used.
  • We urge you to write your own comment letter: Go to – the Projects Tab. Look up the project “Leases (Topic 842)". Use the electronics feedback link or, or provide comments in the form of a written letter by submitting comments via email to, File Reference No. 2013-270 or by sending by mail to“Technical Director, File Reference No. 2013-270, FASB, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116.”
  • Every letter counts and there is power in numbers. They have listened to us in the past and changed things to our benefit.

Executive Summary of the Exposure Draft
Estimated timeline per the FASB staff:
-ED issued MAY 16, 2013 with a 120 day comment period ending SEPT 13, 2013 followed by re-deliberation meetings by the Boards beginning in 2014
-This means the new rules will not be issued until 2014
-Transition date likely to be 2017
Lessee Accounting:
-Capitalize all leases @ the PV of the lease payments as defined.
-Some leases (most equipment leases) will have a P&L pattern that is front ended – rent expense replaced by amortization and imputed interest, now called Type A Interest and Amortization (I&A) leases. Some leases (mostly real estate and short term leases of long lived equipment) will have straight line rent expense, now called Type B Single Lease Expense (SLE) leases. Real estate leases are presumed to get straight line expense unless the lease term or PV of rents meet similar tests as current GAAP while equipment leases are presumed to get front ended costs unless the lease term and PV of rents are insignificant compared to the original useful life and current fair value of the leased asset. Insignificant remains to be defined. This different classification rules decision is not good for the lessee customers of TRALA members.
-Lease term = substantially the same as current GAAP definition.
-Variable rents based on a rate (i.e. Libor) or an index (i.e. CPI) are booked based on spot rates with adjustments booked when the rate change changes contractual lease payments. Variable rents based on usage (like excess miles driven) or lessee performance (e. g. sales) are not booked unless used as a tool to avoid capitalization (disguised minimum lease payments).
-Estimated payments under residual guarantees are booked with review and adjustment at each reporting date.
- Short term leases, including most short term renewals, can elect to use operating lease method with additional disclosure.
-Bundled billed full service leases must be bifurcated into a lease portionthat gets capitalized and a services portion that is expensed as incurred. If the lessee can’t find comparable lease only and/or services only pricing to support the bifurcationcalculationthey will have to capitalize the full payment. This is not good for lessee customers. Lessors will likely be asked for a breakdown but that is considered proprietary information and would lead to lessees having negotiating leverage to force lower pricing. There should be an easier bifurcation method – say a reasonable estimate - to avoid the lessor revealing details of pricing. The difference between actual and estimates will likely be immaterial.
Lessor Accounting:
- Two methods identified for lessors – The Type A “receivable & residual” (R&R) method (much like the current GAAP direct finance lease method) (covers virtually all equipment leases), and Type B existing operating lease accounting which will cover most real estate leases. There is a short term lease election to use current GAAP operating lease method. The classification tests will be the same as those for lessees (see above).
-Under the RR method assets are the PV of the receivable and a PV residual with earnings recognized using the implicit rate in the lease.
-Certain residual guarantees(only “full” TRAC, where guarantor gets the residual upside are considered minimum lease payments.
-Sales-type gross profits are limited with residual portion of gain deferred until resolved through a sale or release.
- Leveraged lease accounting is eliminated with no grandfathering. This is a FASB only issue.

TRALA’s major issues in summary:

OVERALL Issues:

  • The project is unnecessary as current GAAP is working well (If the AAA study (see below) says GAAP is working - why change it other than improve the accuracy of the footnoted info - then all the rest of our comments go away
  • All that is needed is improved disclosures
  • The complete re working of lease accounting will create significant negative unintended consequences as the current lease accounting GAAP is in line with the US legal and tax systems

LESSEE

  • equipment lease classification is wrong – former operatingleases should get straight line P&L treatment as is proposed for real estate leases
  • lessee accounting is too complex
  • bifurcation of services in a bundled billed full service leases should be easier - possibly with estimates rather than hard numbers as they are hard to find – any differences would be immaterial
  • sale leasebacks with an EBO should still be sales as they are under current GAAP – sale leasebacks are common in the equipment leasing business and some TRALA members may use them to acquire new trucks to add to their portfolio
  • operating lease liabilities are not debt and if not re labeled will cause technical covenant defaults for lessees

LESSOR

  • lessor accounting should be based on the lessor’s business model – either operating lessor or financial lessor
  • the proposed lessor R&R method is only cosmetically different than the current GAAP direct finance lease accountingmethod – don’t change as will cause high IT costs
  • all insured or guaranteed residuals should be financial assets for the lessor as they are under current GAAP

Issues that may be included in a cover letter:

The following are issues and ideas that you may wish to use in writing your comment letter. Please use your own words as the FASB will discount comment letters if they appear to be merely be copies.

Need for the project is questionable

The American Accounting Association (AAA) issued a very important study in July 2013 concluding that the operating lease footnote information is effectively processed by analysts as evidenced by market pricing of debt and equity issued by lessees which reflects the as-if capitalized value of operating lease obligations – this means the current off balance sheet disclosure is working fine. The FASB should be forced to answer the question “Why change things if things are not broken?” – especially when they are changing all of lease accounting in very complex way.

The accounting crisis (Enron etal.) that prompted the SEC to study off balance sheet risks was caused by failing to comply with GAAP – not a deficiency in the rules. The thought that operating lease obligations are “hidden” is refuted by the AAA study that shows that the market understands operating lease obligationsand their financial impact very well.

The Boards have not justified capitalizing operating leases as they are executory contracts from a US legal (UCC) perspective and no other executory contracts are capitalized. The Boards have used the theory that once the asset is delivered to the lessee the contract is no longer an executory contract. The fact is that the lessor has continuing obligations to keep the asset free of liens and to allow the lessee “quiet enjoyment” of the asset while under lease and these lessor obligations are sufficient to cause the US commercial law to continue to recognize the lease as an executory contract. The UCC and bankruptcy laws should be the foundation for the accounting – not an accounting “theory”. There is no need to create a theory or hypothesis when commercial law defines what a lease is and whether the lease creates a tangible asset and true debt.

Approach to standard setting

  • Too much focus on anti-abuse = overly complex implementation. Also the AAA study seems to be saying that the supposed abuse of off balance sheet operating lease accounting is not fooling anyone. Operating lease obligations are not “hidden” as the markets recognize their impact on the creditworthiness of lessees.
  • Failure to test the market = 99% of equipment leases are small ticket and relatively short term so lots of work for no material consequences
  • Rules are theoretical/not practical and do not match legal reality. UCC laws define what leases create assets and which are merely rental contract (executory contracts – what accountants call operating leases) = rent is an operating expense, not all leases are right of use, why not just amend IAS 17/FAS 13 to capitalize operating leases and leave expense as is (straight line average).
  • We question whether a cost benefit study was done up front = rules are overly burdensome, why not just amend IAS 17/FAS 13 to capitalize the value of operating leases and leave lease expense as the straight line average rent?

Rules must be simple

  • No objection to capitalizing a value for operating leaseobligations but leave expense straight line – matches economic nature of right of use lease – rent is an operating expense
  • Leave current capital lease accounting alone – it is logical and matches the UCC and IRS views re leases

Clarity

  • Rights in a lease contract must be analyzed
  • The right of use asset is an intangible contract right (the US bankruptcy laws consider the ROU asset as undelivered services in an executory contract)and the asset goes away in a bankruptcy. The right of use lease liability is not debt and if not properly labeled will cause debt limit covenants to be breached
  • Right of ownership lease asset is a property right (PP&E) and ownership continues beyond lease term and the lease liability is true debt in bankruptcy
  • Display on balance sheet must break out the different types of leases so potential lenders and credit analysts can understand the effects of a possible bankruptcy

LESSEE ISSUES

  • Substance
  • Proposed rules do not reflect the economics of right to use leases (former operating leases) versus right of ownership leases (former capital leases)
  • Right of use leases (former operating leases) are executory contracts which create contract rights (an intangible asset) and a liability that is not debt in bankruptcy
  • Right of ownership leases (former capital leases) create property rights (PP&E) and a liability that is debt in bankruptcy
  • Cost/Benefit
  • 99% of leases are of assets < $5 million in cost
  • Most lessees are small/medium sized companies with unsophisticated personnel and systems
  • Consider a de minimus exception
  • Proposed rules too complex
  • Deferred tax accounting will be required for every former operating lease/executory contract lease unless the lease cost is the average of the minimum lease payments. Most all truck leases have level payments that equal the tax deduction of rent expense but the proposed P&L method for equipment leases will front load costs.
  • The only partial benefit to clarity in reporting is capitalizing thelease liabilitybut former operating lease liabilities and assets are mixed with former capital lease liabilities and assets. This means analysts have less info re leases than under current GAAP without the information needed to adjust the numbers. If lease expense is front loaded, the ROU asset value and P&L do not match the economics of the lease.
  • Lease Classification
  • The project proposes different classification tests for equipment leases and real estate leases that are all legally the same type of contract. This dichotomy lacks a common principle and muddles information that analysts need on the nature of lease assets and liabilities.
  • The project must differentiate leases where the lessee rights are ownership rights (property rights) versus those where the rights are merely use rights (contract rights – intangibles) regardless of the type of asset leased
  • This is necessary:
  • To have a different P&L treatment for different types of leases
  • Straight line rent expense for right to uselease/former operating leases (intangible contract right)
  • PP&E and loan accounting for right of ownership (property rights)
  • To be able to break out the different lease assets on the balance sheet
  • Right to use assets are very different in nature vs. right to own assets
  • Users should know which assets are owned and which liabilities are debt in bankruptcy versus which assets are intangible assets and liabilities that disappear in bankruptcy – this is a major issue for potential lenders who analyze what will happen in a bankruptcy. Proper labeling could avoid technical defaults of debt limit covenants.
  • Straight line expense for right of use/former operating leases
  • Suggest retaining notion that rent as an operating expenseand an operating cash outflow – the view held by most business people
  • Saying that rent has a finance component is an accounting theory not legal reality and it creates complexity unintended consequences as you play out the resulting accounting
  • Closely matches the cash expended as most equipment leases have level payments
  • Matches the tax and legal view of rent being the expense
  • Avoids complex deferred tax accounting
  • Avoids miss matches in cost reimbursement contracts where cash paid for rent is reimbursed yet the P&L shows a front loaded cast pattern
  • Amortizing right-to-use lease asset same as the liability
  • Best approximation of fair value of the asset at inception and throughout the lease term
  • Asset and liability are linked in the same contract
  • Asset and liability cannot be settled independently

LESSOR ISSUES

  • No need for symmetry in lease classification
  • The lessee and lessor have different views of a lease
  • Lessors have either a financial lease model or operating lease model
  • Financial lessors:
  • Lease priced like an investment – equipment sold at expiry
  • IRR of cash flows from rent and residual (implicit rate)
  • Tax benefits are included in the pricing analysis and lessee benefits thru lower lease rate
  • Most are triple net leases - lessee pays operating costs
  • Lessor may provide services but bills lessee for services (full service lease)
  • Operating lessors
  • Current lessor “Operating Lease” model reflects the economics
  • Full service leases
  • Daily rental lessors – rent-a-car, hotels
  • Short term leases
  • One asset leased to multiple lessees
  • Lessor incurs operating expenses related to asset

Suggested approaches to improve the benefits in the ED using the idea that accounting should
- reflect the substance of the transaction,
-provide lessees with key information they need and
-provide key information that users (lenders and credit analysts) need to analyze lessees’ creditworthiness and the impact of a bankruptcy

ED Issue / Substance / What preparers need / What users want
Lessee accounting /
  • Classify by legal/economic nature
  • Tangible vs. intangible asset
  • True debt vs. a going concern only liability
/
  • Information for tax return preparation
  • Information to give potential lenders
/ Information re: treatment of lease assets and lease liabilities in bankruptcy
Lessor accounting / Finance vs. operating business model
– Finance lessors view and price each lease as a discrete investment with the assumption they will sell the leased asset when returned. Their leases should all be finance leases
-Operating lessors buy assets on spec, lease them over and over again, maintain the assets and the pricing is market rates (biggest factor is supply and demand not the time value of money). The equipment is considered their stock-in-trade. Their leases should all be operating leases.
-Symmetry does not reflect that the lessee’s view is “do I own the leased asset or am I renting it”, while the lessor may be viewing the same lease as a discrete investment or an operating lease – the lessee does not care what the lessor business model but rather only cares about the right to use the asset. / Internal management accounting uses business model info to manage the business / Finance leases (DFL method) for financial lessors/operating leases for operating lessors – meshes with ratios & measures employed by users to evaluate lessors.
Sale and Leaseback with EBO / It is legally a sale under a risks and rewards analysis which is line with the tax view / Need only “owned” assets for all types of tax compliance and to provide information for potential lenders / Users want clear picture of assts that survive bankruptcy (the true at-risk assets)

Cost/Benefit Grid – suggestions to improve the benefits and reduce the costs