Leaseurope & IASB/FASB Meeting

Leaseurope & IASB/FASB meeting

London, 28 January 2010

Summary

Leaseurope’s Chairman, Rüdiger von Fölkersamb, thanked the IASB and FASB for providing the European leasing industry with the opportunity to stress its concerns on the direction the lease accounting project is taking, particularly with respect to lessor accounting and referred the Boards to Leaseurope’s comment letter of 25 January on the issue.

To kick off the meeting, Tanguy van de Werve gave a brief presentation on the importance of the European leasing market and its contribution to the European economy, highlighting the substantial share of investment financed by leasing and the high level of use of leasing by Europe’s SMEs (that make up around 50% of the lessor customer base). To support Leaseurope’s message that the vast majority of leases are for straightforward, relatively low value assets, an overview of the types of assets financed by leasing was provided together with information on the number of leases granted in a year and the average deal size (around €40,000 per deal). Additionally, the presentation covered the numbers and types of leasing firms that operate on the European market and their use of different distribution channels.

As an introduction to the discussions on lessor accounting, Rüdiger von Fölkersamb recalled the various high level principles that any lessor accounting model should adhere to, asset out in Leaseurope’s comment letter.

Mark Venus began the lessor accounting discussions by explaining why the performance obligation (PO) model is inconsistent with the right of use model for lessees developed in the Discussion Paper (DP). In the DP, the lessee’s obligation is defined as being unconditional, the justification being that the lessor has performed whereas the Boards are now saying that the lessor still has the obligation to perform (i.e. make the asset available, etc.). Moreover, the DP says that the lessee controls the right to use the asset, which implies that control of this asset has been given up or transferred by the lessor. This also implies that an asset can be viewed as a bundle of rights that can be separated and transferred.

The members of the Leaseurope delegation provided further insight into why a lessor does not have the performance obligation described by the Boards. Indeed, once the leased asset has been delivered to the lessee, the lessor has performed its obligation to the client and, during the lease term, the lessor does not control the asset and cannot access it.It is therefore difficult to understand why a lessor would have to account for the full value of the asset on its balance sheet. This was further illustrated by means of an example where an entity acquires two identical assets, keeps the one for its own use and leases out the other. If the asset that is kept for the entity’s own use is impounded, confiscated or stolen, although the entity may hope to recover it at some point, it would impair its value for not being able to use it for a certain period. The delegation argued that the asset that had been leased out should be treated in a similar manner as the entity cannot make use of it during the lease term.

It was also pointed out that in many cases, it was the customer who chose the asset and then went looking for a means to finance it (via a lease) and that this was a different type of model to real estate leasing for instance where a real estate company would first build the asset and then look for clients to rent it out to.

This discussion was followed by an overview of the impacts of the performance obligation model, the most obvious implication being that this approach creates multiple assets, whereas in reality there is only one physical asset generating one stream of economic benefits. According to members of the Leaseurope delegation, this multiplication of assets is exacerbated in sublease situations, which are common place within the leasing industry, and does not help improve the transparency of financial statements.

The delegation pointed out that the inflation of lessor balance sheets under the PO approach leads to a reduced return on assets, an increase in leverage, possible capital consequences for regulated lessors and a skewed net result leading to distorted and variable financial and efficiency ratios. The approach also hampers the comparability of lessor accounts compared to those of secured lenders. The delegation noted that a net presentation approach of the PO model would alleviate some of the distortions created with gross presentation but, as it was still based on flawed assumptions, it was not preferable to the de-recognition approach. Moreover, even under a net approach, a lessor’s financial and performance ratios remain variable where users would expect them to be constant.

It was stressed that, while the effects of any PO approach would obviously be directly detrimental to lessors, ultimately the application of such a model could lead to more expensive funding and/orrestrict businesses’ access to finance, particularlyfor small businesses. This is because the PO approach could very well lead to a reduction in leasing activities, with former leasing clients turning to bank desks to obtain financing where additional collateral may be required or where loans may be turned down/become more expensive given a lack of collateral.

The delegation also presented an example of the same lease contract accounted for under the de-recognition model, the performance obligation model with gross presentation and the performance obligation model with net presentation. This example included an analysis of several ratios under the various approaches. The IASB/FASB Board members acknowledged the usefulness of the numerical examples and ratio calculations and thanked Leaseurope for providing them.

Leslie Seidman recalled that the leases project was initially focused on lessee accounting but that this decision was reversed to include lessor accounting in order to have an internally consistent model. At the same time, given that the Boards are working on a general revenue recognition project, this was also driving accounting for lessors as the Boards are striving to achieve consistency between lessor accounting and revenue recognition. She said that while understanding Leaseurope’s points on the transfer of the right of use, she did not accept that the lessor had completely performed as there was always continuing involvement from the lessor and if the lessor had performed, that would trigger full day one revenue recognition. She appeared to be under the impression that lessors would (or currently do) recognise all types of revenue upfront.

She also commented that the Boards were heading towards net presentation under the PO model and questioned whether they needed to adapt their views on lessor accounting to fit in with the right of use model for lessees or whether they should actually change their rationale on lessee accounting.

Larry Smith stated that one of the reasons the Boards had preferred to go for the PO model was because they had concerns relating to services bundled in the lease and that lessors would not be able to separate these.

In response to these comments, the Leaseurope delegation reiterated its arguments that the lessor had indeed performed and pointed out that interest income and income from any services provided together with the lease would never be taken upfront. Even under a de-recognition model, sales type revenue would only ever be recognised by manufacturer lessors as third party lessors should not be able to de-recognise more than the cost of the leased asset (this was how their lease pricing worked).The delegation argued that manufacturers should be allowed to recognise sales revenue: they had gone through an added value production process and effectively sold a right to use the produced asset. Whether this revenue recognition should be proportional to the right of use sold or not was a question that could be resolved independently.

It was also pointed out that manufacturers would have to use third parties if they wanted to obtain revenue recognition and continue leasing (which currently accounts for a substantial part of their business). Various other manufacturer/lessor mechanisms involving dealers and syndication were explained to the Boards with little reaction.

The delegation also took the opportunity of discussions on revenue recognition to clarify that a de-recognition model avoided the complexity of having to scope out “leases that are purchases” whereas the Boards would be forced to make this (artificial) distinction if they followed the PO route.

Moreover, the delegation clarified that lessors would always be able to separate service components from lease payments but that this may not be the case for lessees. Rachel Knubley commented that the separation of service payments from payments for the right of use could also be an issue for lessees.

Patrick Finnegan explained that his view was that an asset represents a right to future cash flows and that a right of use asset did not create future cash flows. In his opinion, a lease created a new right and therefore the performance obligation model correctly reflected this situation. Mark Venus reacted by clarifying that a lease did not create a new right; instead, the lessor was exchanging its existing rights (transferring them to the lessee) for a right to receive a rental cash flow. Larry Smith commented that this was why he felt net presentation under the performance obligation model would appear to be the better option.

When asked by Patrick Finnegan whether lessors would prefer today’s lessor model to a de-recogntion model, the delegation explained that Leaseurope was of the opinion that a complete overhaul of the existing model was not necessary and that many of the structuring issues the Boards are seeking to deal with could be addressed by avoiding US GAAP bright lines and better applying current IAS17 principles. It was stressed that given the average deal size and a lessor’s margin on those typical deals, there was no room to structure a transaction if bright lines were removed. However, if the Boards did decide to apply a right of use model for lessees, they would have to change lessor accounting too and the industry considers that the only model that is consistent with this approach is de-recognition.

The delegation clarified that other reasons for dismissing the de-recognition model such as its application to leases of assets with long economic lives (e.g. property) was an issue of asset valuation and was therefore independent from lessor accounting and could be resolved by requiring fair value measurement of such assets.

Commenting on the proposed treatment for leases with complex features such as options and contingent rentals, the industry delegation recalled Leaseurope’s position on the lessee side which is that lessees should not include these in their obligation to make payments as they do not meet the definition of a liability. Consequently, on the lessor side, the inclusion of payments under optional periods/contingent rentals in a lessor’s receivable was of even greater cause for concern as lessors would be overstating assets.

Leslie Seidman asked if Leaseurope was aware of the Boards’ decision to include a measurement reliability threshold for lessors. Reacting to this comment, the delegation pointed out that this decision had been made only for contingent rentals and not for options. Moreover, several cases of lessor bankruptcy could be attributed to lessors overstating assets and the chosen approach did therefore not appear to be appropriate. Seidman explained that users appeared to favour an overstated uncertainty to a certain understatement (from the lessee perspective?).

Patricia McConnell enquired whether Leaseurope considered its lessor model to be consistent with the revenue recognition project, to which the delegation responded that it was (for the reasons stated above). It also became apparent that some Board members consider that a lessor can have two performance obligations: one at the inception of the contract and another one to continue to make the asset available after delivery. The industry delegation repeated that it did not consider that lessors have the second performance obligation.

The Boards recommended that the industry follow developments in the revenue recognition project closely as leasing was often discussed in this context.

The Leaseurope delegation also took this opportunity to comment on the general direction of the emerging lease accounting model and stressed that the lessee model envisaged in the Discussion Paper was far too complex. For instance, even straightforward lease contracts such as vehicle contract hire are subject to changes in milage and the complexity for these types of small value, high volumes leases would be the greatest and would not actually help improve transparency of the lessee’s financial position.

The delegation cautioned that the Boards should not underestimate the burden for preparers to have to separate service payments from payments for the right to use the asset and that generally they would have to address the fundamental issue of the difference between leases and executory contracts.

Commenting on recent decisions to provide a “concession” for short term leases, the delegation explained that the industry needed more time to understand the implications of the proposals but that a clear form of relief was required to avoid the complexity of the current approach. Moreover, a sufficiently long period between finalisiation of the standard and its effective date would be required to allow preparers to identify their leases (today many rentals are not considered to be leases) and adapt their systems.

Lastly, the delegation pointed out that the lessor chapter in the DP did not provide constituents with sufficient opportunity to comment on lessor accounting and that a new Discussion Paper, covering both lessee and lessor accounting was necessary, together with a full cost/benefit analysis, including field testing. The various changes in the project’s scope regarding lessor accounting was also singled out as a factor that made providing constructive feedback to the project extremely challenging, thus further underscoring the need for a new, comprehensive Discussion Paper. Moreover, a new Discussion Paper is required in order to allow the users of lessor accounts to reflect on the proposals before a standard is issued. In particular, supervisors and regulators are important users of lessor accounts and they must be involved in the standard setting process whereas they do not appear to have been consulted to date.

Participants

Industry delegation:

Rüdiger von Fölkersamb(Deutsche Leasing)

John Bennett(Banc of America Leasing)

Ward van den Dungen (Océ)

Jukka Salonnen (Nordea)

Guus Stoelinga (LeasePlan)

Mark Venus (BNP)

Tanguy van de Werve (Leaseurope)

Jacqueline Mills (Leaseurope)

IASB/FASB:

IASB:

Patrick Finnegan (IASB Board Member)

Patricia McConnell (IASB Board Member)

Sunhee Kim (IASB Staff, Technical Associate)

Rachel Knubley (IASB Staff, Senior Project Manager)

Gavin Francis (IASB Staff, Director of Capital Markets)

FASB:

Larry Smith (FASB Board Member)

Leslie Seidman (FASB Board Member)

Danielle Zeyher (FASB Staff, Project Manager)

Russell Golden (FASB Staff, Technical Director)

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