IFRS Blog

Leases: Long Overdue Changes Proposed

The Financial Accounting Standards Board and the International Accounting Standards Board are looking to rewrite current lease accounting standards. In their Discussion Paper Leases: Preliminary Views, the Boards outline conceptual problems with current lease accounting and advance proposals to put operating leases on the balance sheet.

Current lease accounting standards are derived from the view that a lease that transfers substantially all of the benefits and risks of ownership should be accounted for as acquisition of an asset and incurrence of an obligation by the lessee. Other leases should be accounted for as operating leases. Operating leases are treated as rentals of property and the associated assets and obligations are not recognized on the balance sheet.

Many believe that existing standards are conceptually flawed and that operating leases give rise to assets and liabilities that should be recognized in the balance sheet of the lessee. The lessee obtains a valuable right (the right to use a leased item) and this right meets the definition of an asset. Similarly, the lessee assumes an obligation (the obligation to pay rentals) and this obligation meets the definition of a liability.

The FASB and IASB agree that the current rules are flawed and have proposed a new accounting model for leases that will put rights and obligations of leases on the statement of financial position.

There are a lot of details to be worked out including how the new proposals will affect accounting by lessors – the current discussion paper is focused on the rules for lessees. However, the changes proposed to lease accounting standards are long overdue. Lease financing is a significant source of financing for many companies. A new standard will put these obligations on the balance sheet where they belong, giving financial statement users a more complete picture of a company’s financial position.

One interesting aspect of this debate is how long it has been occurring. I went back to my old intermediate accounting text book which was published in 1980. In the last paragraph of the lease chapter, the authors noted that a change in the official view of leases may be forthcoming. They were referring to accounting for lease rights and obligations in the balance sheet. They also mentioned that this view was recommended by AICPA Accounting Research Study No. 4 in 1962.

Do you agree or disagree with the need to rewrite the rules for leases? Let us know what you think.

 

- Paul Parks

Rewriting Revenue Recognition

On December 19, 2008, the Financial Accounting Standards Board and the International Accounting Standards Board issued a Discussion Paper titled, Preliminary Views on Revenue Recognition in Contracts with Customers. The joint project was initiated to clarify principles for recognizing revenue. This project is a major step toward convergence of U.S. GAAP and IFRS and is expected to lead to a single standard for revenue recognition.

Today, revenue and gain recognition guidance comprises more than a hundred standards in the U.S. Many of the standards are industry specific and contain detailed and complex prescriptive guidance. In contrast, International Financial Reporting Standards offer just two standards, which provide limited guidance and can be difficult to apply, especially for transactions involving multiple components and multiple deliverables.

The Discussion Paper introduces a contract-based revenue recognition model. The proposed model would apply to contracts with customers. Revenue recognition would be driven by increases in an entity's net contract with a customer, defined by a combination of rights and obligations. Revenue is generated when an entity satisfies performance obligations. Satisfaction of performance obligations occurs when an entity transfers a promised asset (such as a good or a service) to a customer. Transfers occur when the customer obtains control of an asset.

The Discussion Paper highlights potential effects on current practice. Specific areas mentioned include revenue under construction-type contracts, warranty and other post delivery services, cost capitalization and multiple element arrangements. The new model could have a significant impact on contractors, software companies and other companies with exposure to the areas listed above.

Two problems with U.S. GAAP that a new standard would address include numerous standards that define the earnings process inconsistently and gaps in guidance. Guidance today is complex and voluminous. Having a general standard for revenue recognition as a foundation for all revenue accounting makes sense--especially to address gaps that exist in guidance.

One concern is replacing all of the existing industry specific guidance with a single general principle. Rules have evolved over the years to address many unique, industry-specific matters and this is a significant step away from these rules.

Is replacing existing guidance (including industry specific guidance) with a single revenue recognition standard the right direction to go?

Share your thoughts with your colleagues on this very important proposal. In addition, the AICPA is looking for volunteers to provide feedback to be included in a response letter on how the proposed revenue model will impact their business. For more information and to submit your name, visit http://volunteers.aicpa.org/.

- Paul Parks

Is More Too Much?

The Financial Accounting Standards Board and the International Standards Board issued a discussion paper titled Preliminary Views on Financial Statement Presentation. The joint project between the boards was initiated to address concerns that existing presentation requirements permit too many alternative types of presentation and that information in financial statements is highly aggregated and inconsistently presented.

The discussion paper introduces the concepts of disaggregation and cohesiveness. A detailed explanation of these concepts and all of the changes under the Discussion Paper is beyond this narrative; however, you should be aware that the discussion paper introduces significant changes to the presentation of information in financial statements.

Under the concept of disaggregation, the income statement will provide more detail. Revenue, costs and expenses will be disaggregated by nature and function. Instead of having one line item for selling, general and administrative expenses, for example, these expenses will be expanded to multiple lines by nature (selling, general and administrative) and then by function (salaries and wages, advertising, depreciation, etc.). In the balance sheet, you will see more line items. Many accounts that used to be lumped in other current assets or other current liabilities will require separate lines.

The goal of cohesiveness is to make the relationship between items across financial statements clear. In attempt to make the financial statements flow together, the balance sheet will include separate sections for operating, investing and financing assets and liabilities.

While the concept of net income is retained, the basic income statement is not. It will be replaced by a required single statement of comprehensive income. For the cash flow statement, the proposal prohibits the use of the indirect method and requires the direct method. The financial statements are then pulled together by footnote disclosures that require a detailed reconciliation of cash flows to comprehensive income.

Changes introduced in the discussion paper may be welcome by many. However, others may be concerned that the proposals go beyond what is needed and introduce changes that will make financial statements too detailed and less useful.

Have you had a chance to read the discussion paper? What do you think about the proposals? The comment period is open until April 14, 2009. Instructions for submitting comments are included in the Discussion Paper.

- Paul Parks