Compromise for Lease Accounting Overhaul Has Been Rejected by the Leasing Industry Accountants and Analysts
Since 2006, the U.S. Financial Accounting Standards Board and the IASB have been working on a lease accounting overhaul. This effort has been spurred by investor complaints that huge off-balance sheet leases can blur a company’s true financial obligations. On May 16, 2013, the FASB and IASB issued their joint Exposure Draft (“ED”) on lease accounting. Comment letters were due to the FASB/IASB in September 2013. The May 2013 ED would have brought virtually all leases with a tenor of one year or more onto the balance sheets of both lessors and lessees. The SEC estimated that the accounting proposed by this ED would add an average of $1 billion in new assets to the balance sheets of S&P 500 companies.
Reacting to prior criticism about the income and expense recognition patterns in the 2010 ED, the MAY 2013 ED proposed a complex framework of dual lease classification. Leases would either be classified as either Type A or Type B. Under a Type A lease the amortization would look similar to that of a financial asset. Whereas, Type B leases, which were created in response to complaints that not all leases are like asset financings, would allow expense recognition on a straight-line basis.
The Boards received 638 comment letters on the May 2013 ED. Based on the mostly critical feedback in these comment letters, the Boards decided to begin re-deliberations of all significant issues in the first quarter 2014. The more significant topics discussed at the meeting are summarized below:
- There are serious concerns about the complexity of the proposal as it relates to numerous issues, including lease classification and subsequent measurement.
- The majority of constituents do not support changing the existing lessor accounting model, expressing a position that the existing lessor model is not fundamentally flawed. Those constituents do not think that consistency between the lessee and lessor accounting models is necessary.
- Many respondents support the concept that lessees should recognize lease assets and liabilities on their balance sheets. However, there are mixed views regarding the income statement and cash flow statement proposals. Some support a single lessee accounting model; others support a dual lessee accounting model.
On January 23, 2014 the FASB and the IASB began their re-deliberations of the proposals included in the May 2013 Leases Exposure Draft. The objective of the meeting was to have an in-depth discussion of the following:
– Lessor accounting model
– Accounting for “Type A” leases by lessors
– Lessee accounting model
– Lessee small-ticket leases.
The Boards did not make any decisions at this meeting.
Implications of the Volcker Rule
Five Governmental agencies (The Board of Governors of the Federal Reserve System, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, Securities & Exchange Commission, and Commodity Futures Trading Commission) concluded their three year collaboration passing the final Volcker rule on December 10, 2013. It ushered in a ban on proprietary trading for banking entities. The rule is effective April 1, 2014, with a conformance timeline running through July 21, 2015, unless extended.
The ban on proprietary trading will affect the banking entity’s relationship with hedge funds, private equity, and covered funds, in many instances terminating the relationship. A myriad of exemptions apply for all prohibited actions – proprietary trading, hedging, covered funds, etc. The affected firms will have to look closely at the exemptions in order to completely understand the proper actions to take.
The Volcker Rule restrictions on covered funds may impact community banks that invest in Collateralized Debit Obligations (CDO’S), Collateralized Mortgage Obligations (CMO’s) and/or Collateralized Loan Obligations (CLO’s). Trust preferred CDO’s issued prior to May 19, 2010 are exempt from the Rule. Aside from that exception, banks which have invested in CDO, CMO and CLO securities will be required to identify their specific hedging risks, and monitor the effectiveness of those hedges as consistent with their policies.
The final Rule exempts Community and Regional banks with less than $10 billion in total consolidated assets from trading restrictions and compliance requirements with respect to trading in U.S. Treasuries, GSE Agencies, Municipals, and FDIC obligations. Even with an exemption or exclusion in every aspect of the Volcker Rule, all banking entities would be wise to review their portfolios, risk policies and procedures and draft a compliance program.
Wall Street Journal: The Volker Rule with Notes:
Debevoise & Plimpton Client Update: The Volker Rule: An Overview:
Sandler O’Neill + Partners: The Volcker Rule’s Impact on Regional and Community Banks:
Wall Street Journal: Regulators May Again Clip Volcker