Lease Accounting Moves; Retail Issues; More

Fulfilling a promise they made this spring, accounting rulemakers in the United States and abroad have opened a new, long-term project to rewrite lease accounting rules.

The Financial Accounting Standards Board and the International Accounting Standards Board met separately last week, each deciding to adopt a joint project, with a goal of issuing a preliminary discussion paper in 2008. The boards plan to form a joint working group that will lay a foundation for deliberations beginning in 2007. Given the enormity of the undertaking and the boards’ existing workloads, rule changes might not actually occur until 2009.

The boards may decide on a phased project—similar to FASB’s two-part approach to rewriting pension rules—to pursue some immediate improvements, especially on the lessee side of a lease transaction. FASB members have voiced concern that tricky issues on the lessor side of a lease transaction, the minutiae of small transactions, and the joint approach with international standards-setters, all could bog down the rulemaking process and delay prospective early improvements.

Seidman

A comprehensive overhaul of lease accounting has been “a long time coming,” FASB member Leslie Seidman said. “I view part of our mission as revisiting existing standards when we have clear indication that the current accounting standards are not producing information that is useful to investors. In this case I think we have received a clear signal that the investing community does not believe the current accounting standards are providing them all the information that they need.”

The Securities and Exchange Commission targeted lease accounting as an area ripe for improvement in its 2005 report on off-balance sheet accounting. Current rules contained in the 30-year-old Financial Accounting Standard No. 13, Accounting for Leases, enable companies to keep much of the liability they assume with lease transactions off balance sheets, which has proved pivotal in some high-profile accounting frauds and corporate failures in recent years (see details in box above, right).

The core issues in lease accounting rest in the distinction between capital leases and operating leases. Capital leases look like an asset purchase and are recorded as an asset and a liability on the balance sheet. Operating leases, however, are treated more like a rental agreement with costs expensed from the income statement. By structuring leases to escape the definition of a capital lease, companies typically are able to keep a majority of their lease arrangements off the balance sheet.

FASB is looking for expertise on all fronts of the lease transaction to participate in the working group. Nominations will be accepted through September.

Emerging Issues Group Ponders Complex Retail Transactions

As retailing and marketing strategies grow increasingly complex, so does the accounting. Now FASB’s Emerging Issues Task Force is targeting one specific arrangement that seems to be escaping existing guidance issued in 2001.

The EITF wants feedback on its proposed approach for how accounting should be handled when a consumer buys a product for which an equipment provision involves a third party other than the manufacturer or reseller.

The EITF thought it had resolved the question with Issue No. 01-6, published in 2001, when it addressed how to account for any consideration a vendor gives to a customer, including a reseller of the vendor’s products (see box at right).

Graul

“With any accounting issue, companies look for ways to do something similar but not necessarily within the confines of the pronouncement,” says EITF member Lee Graul of BDO Seidman. The proposed guidance “basically says when you’ve got one of these arrangements, you have to go through and consider the type of benefit provided.”

Graul says the EITF decided to focus on the issue because of increasing arrangements where car manufacturers install radios that include service offerings to the end consumer.

“There are many ways it can be done, but the manufacturer doesn’t pay full price for the radio, and the benefit may or may not be passed along to the future end consumer,” Graul says. “How does the service provider account for the incentive provided to the manufacturer or the end-user of the product? We’ve attempted to create a model that hopefully will cover the accounting for both cash and non-cash consideration.”

Markowitz

There is a growing trend for manufacturers and resellers to bundle goods or services to make their offerings more appealing, according to Alan Markowitz, an audit partner with J.H. Cohn. “In today’s competitive environment, a company must often modify standard sales arrangements with value-added products and services to entice the buyer to complete the sale,” he says.

The ongoing accounting challenge is how to recognize the revenue, Markowitz says. “There is no one-size-fits-all method of measuring and accounting for benefits resulting from multiple element arrangements.”

Separately, the EITF also issued proposed positions on how to properly account for certain split-dollar life insurance arrangements and certain other life insurance purchases.

AICPA Provides Guide To Audit Alternative Investments

The American Institute of Certified Public Accountants is giving auditors a roadmap for how to audit alternative investments when the fair value can’t be tied easily to a single metric or market index.

The AICPA issued a practice aid for auditors, “Alternative Investments—Audit Considerations,” that doesn’t establish any new rules, but explains how existing standards apply to the audit of alternative investments, such as derivatives or hedge funds.

Glynn

“It’s a real challenge for a lot of companies to back up their financial statement assertions with respect to valuation on these things,” says Michael Glynn, technical manager in the AICPA audit and attest standards team. “A lot of folks are taking a number from the fund manager and running with it. That’s just not good enough.”

The practice aid guides auditors through a variety of issues, including how to address management’s assertions, management representations, disclosure of certain significant risks and reporting. The aid includes examples and illustrations. (See box above, right.)