FASB and IASB Make Progress on Joint Standard
Moving closer to a final standard that will mandate companies to add most of their lease liabilities on balance sheets, the Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board (“IASB”) have come to an agreement on several provisions of their lease accounting project. Meeting on April 23rd via videoconference, the boards sought to curtail differences that are keeping them from creating a joint standard for FASB’s Proposed Accounting Standards Update No. 2013-270, Leases (Topic 842), and IASB’s Exposure Draft No. 2013-5, Leases, as well as offer more clarity about lease contract revisions.
Most notable from the four-hour meeting, the FASB and IASB agreed on guidance for outlining the terms of a lease’s contract, when it is suitable to merge two or more contracts and questions regarding the discount rates businesses employ when assessing lease liabilities. Per the agreements, the boards stated a lease modification is now defined as any adjustment to the lease’s terms and conditions that was not part of the initial contract. When deciding if a lease has been modified, a company would consider the core of the entire contract. In addition, if the customer receives rights to property or equipment that isn’t in the initial contract and the contract fixed the price to replicate the changes, the lease modification would be deemed as a separate new contract. A lessee must also take into account lease adjustments that are not separate new leases centered on whether the adjustments change the extent of the lease or its payment.
Further, the FASB and IASB defined when it is appropriate to merge two or more contracts. A company can now claim two or more contracts as one transaction if they were submitted at or around the same time, with the exact counterparty, as well as if the contracts are converted into a package with one commercial objective, or the price of one contract is contingent on the cost or performance of the former contract.
In its discussion on the discount rate for deciding a lease’s present value, the FASB and IASB said companies renting equipment or real estate should reduce their liability at the rate charged by the lessor or landlord. If there is no stated rate, the company should use its “incremental borrowing rate,” meaning the rate that the lessee would have encountered to borrow money for purchasing the leased asset.
Additionally, the boards took into account numerous recommendations made by their research staffs, thereby agreeing on:
- Modifying the meaning of the lessee’s incremental borrowing rate to tackle the concerns brought forth;
- Application guidance for discount rates;
- Clarifying when a lessee that is a subsidiary of another company can decide its discount rate through its parent company’s credit rating or other information;
- Describing the rate the lessor charges the lessee as contained in the lease; and
- Not requiring lessors to reevaluate discount rates and for lessees to reassess the rate solely when the lease term or assessment changes.
Despite their progress, the FASB and IASB still are at odds on how companies should note expenses on their income statements. While most IASB members want the majority of lease expenses to be seen as financing transactions using interest and amortization assessed as part of the rental expense, most FASB members feel some leases should be treated like modest rental expenses, with the income statement showing even payments over time.
The income statement pattern is viewed as an essential part of the proposed joint standards. If the boards fail to agree on what should be listed on the income statement, then the project could fall apart.