Regulatory Watch: Convergence Takes Another Hit

April 15, 2014
FASB’s retreat on lessee accounting is another blow to convergence.   

Strike another blow against converging accounting standards worldwide, and breathe a sigh of relief that more significant changes to multinationals’ current accounting systems and policies and procedures will no longer be necessary.

The Financial Accounting Standard Board (FASB) and the International Accounting Standards Board (IASB) agreed to disagree on the issue of lessee accounting during their meeting March 18 and 19. Both standard setters are moving ahead with putting all leases on the balance sheet—leases’ off-balance-sheet treatment was a factor originally prompting the project—the FASB will retain both operating and financial leases, as is the case with current generally accepted accounting principles (GAAP).

The IASB, instead, will continue down the path of accounting for all leases as financing contracts. The move, if finalized, would require U.S.-based multinationals to translate statutory reporting they perform for foreign subsidiaries under the IASB’s International Financial Reporting Standards (IFRS) to U.S. GAAP for their consolidated financial statements, as they do now.  A shift in the IASB’s direction could have resulted in significant changes to lessee’s accounting systems and policies and procedures.

Robert O’Brien, Partner and Vice Chairman, U.S. Real Estate Services Leader, Deloitte & Touche, noted that the optimism when the standard setters initiated their convergence efforts in 2007 has faded, as they dug into the details and reality set in.

In a February 19 meeting, the FASB narrowed the scope of a proposed insurance standard so that its impact is limited to insurance companies, while the IASB’s version would include transactions by non-insurance companies that have insurance-like components. In January, the FASB said it was no longer pursuing convergence for the classification measurement and impairment portions of the financial instruments project.  

“The FASB is going clarify current accounting and make some modifications, but ultimately it’s not moving far away from the existing U.S. GAAP, while the IASB is moving further away from current IFRS,” Mr. O’Brien said.

Mr. O’Brien added that one of the few projects he anticipated seeing convergence centered around revenue recognition. The FASB and IASB announced in early 2013 that they had agreed on a converged standard and that a final version would be issued in the first part of this year.

In terms of lease accounting, FASB issued its first exposure draft in 2010, and after receiving significant push back from industry participants issued a revised version last May. The two boards agreed to capitalize leases, putting them on the balance sheet, to address concerns that lessees’ were not accurately reflecting their liabilities in the financial statements.

However, FASB decided at the March meeting to pursue an approach similar to current accounting, in which two categories of leases are recognized. Assets with significant residual value at the end of the term are categorized as operating leases and the expense associated with the lease is recognized in equal increments throughout the life of the lease. That approach tends to sync better with current U.S. commercial law and tax law for those types of transactions, when the expense if more akin to a rent.

Financing leases typically are used when the lease is essentially financing the purchase of the asset and there is little to no residual value when it expires; for example, leasing a car for the entire life of the vehicle. The IASB decided to pursue accounting for all leases in that fashion, where the lease expense is recognized more like the interest expense on a loan, and the interest is higher early in the loan when there’s more principal.

“When you view the lease as a right to use an asset for some period of time, and then that asset goes back to the owner and still has significant value, it raises the question ‘Why should the rent expense be dramatically different in year one compared to year 10?’” O’Brien said.

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