The Conceptual Framework and Accounting for Leases.(Statistical Data Included)

Publication: Accounting Horizons

Publication Date: 01-SEP-01

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COPYRIGHT 2001 American Accounting Association

SYNOPSIS: For years, users of financial statements, academics, and standards setters alike have criticized the lease accounting standards as unnecessarily complex and ineffective in portraying liabilities arising from lease contracts in the balance sheets of lessee enterprises. Recognizing that current standards were adopted before the Financial Accounting Standards Board (FASB) and other standard-setting bodies completed their conceptual framework projects, critics of the lease accounting standards contend that the principal defect in existing standards is that they are at variance with the definitions of assets and liabilities in those frameworks. Some, including the Chairman and several other charter members of the newly formed International Accounting Standards Board (IASB), have called for new lease accounting standards anchored securely in the framework definitions of assets and liabilities. There is not universal agreement, however, on exactly what assets and liabilities result from applying these defi nitions to a lease contract. For companies that lease a significant amount of physical plant, financial statements produced under the two alternative interpretations explored in this paper are radically different.

This paper proposes a decision model for choosing between two alternative interpretations of the definitions of assets and liabilities in a leasing context, illustrates the effects on the basic financial statements of a lessee enterprise of applying these two alternative interpretations, and evaluates the results using the proposed decision model.

BACKGROUND

Standard setters, academics, auditors, users, and preparers of financial statements have long debated whether or when assets and liabilities result from lease contracts. In a very real sense, a workable method of reporting leases in the financial statements of lessees has been the Holy Grail of accounting standard setters in this country for at least 40 years. Neither the Accounting Research Committee of the AICPA nor the Accounting Principles Board was able to build a consensus for doing anything substantive with this issue.

The newly formed FASB took up the subject of accounting for leases as one of its first priorities and, during the first seven or eight years of its existence, the FASB devoted nearly half of its staff resources to lease accounting issues. The focus of these efforts, Statement of Financial Accounting Standards No. 13, Accounting for Leases (FASB 1976, SFAS No. 13), clearly represents progress when compared to all previous attempts at developing lease accounting standards. Nevertheless, despite multiple revisions including nine FASB amendments, six FASB Interpretations, 12 FASB Technical Bulletins, and EITF consensuses too numerous to count, there is virtually universal agreement that SFAS No. 13 fails to achieve its stated objectives and needs to be reconsidered.

I first became involved in the lease accounting standard-setting process as a young manager in the San Francisco office of KPMG, when I assisted my firm's national office in responding to the two FASB Exposure Drafts that culminated in the issuance of SFAS No. 13 in November 1976. Later, I met annually with the FASB and its staff to discuss FASB projects affecting the leasing industry and assisted in developing industry-specific responses to various FASB proposals to amend SFAS No. 13. Initially I was a member of the Accounting and Finance Committee of the Equipment Leasing Association of America (ELA) and later I served as an Associate Member of the ELA Board of Directors. After transferring to the Department of Professional Practice in KPMG's national office in 1992, I also served for several years on a Working Group formed to advise the EITF on various lease accounting issues. In March 1999, I accepted appointment to the Financial Accounting Standards Advisory Council, which meets quarterly with the FASB and its staff to discuss the Board's current and possible future standard-setting agenda. As auditor of or advisor to lessee and lessor companies, over the past 30 years I have read literally thousands of lease contracts conveying the right to use every conceivable type of equipment and real estate for periods ranging from one day at a time to 75 years or more.

TWO ALTERNATIVE CONCEPTS OF LEASE ACCOUNTING

During the deliberations that preceded SFAS No. 13, some argued that all lease commitments create obligations that should be reflected as liabilities in the balance sheets of lessees. However, the FASB disagreed. The provisions of SFAS No. 13:

derive from the view that a lease that transfers substantially all of the benefits and risks incident to the ownership of property should be accounted for as the acquisition of an asset and the incurrence of an obligation by the lessee and as a sale or financing by the lessor. All other leases should be accounted for as operating leases. (FASB 1976, para. 60)

By preserving in SFAS No. 13 the distinction between operating and capital leases previously articulated in Accounting Principles Board Opinion No. 5 (AICPA 1964), the FASB agreed that some leases give rise to assets and liabilities and others do not.

Following SFAS No. 13's appearance in November 1976, the International Accounting Standards Committee and the standard-setting bodies of Canada, the United Kingdom, Australia, and New Zealand all adopted lease accounting standards patterned after the FASB's approach. Together, representatives from the FASB and these standard-setting bodies comprise the G4+1, an informal organization devoted to furthering the shared standard-setting objectives of their respective participating organizations through analysis and discussion of financial-reporting issues of mutual interest.

In July 1996, the FASB joined with the other G4+1 organizations to publish a Special Report, Accounting for Leases: A New Approach. Authored principally by Warren McGregor, at that time Executive Director of the Australian Accounting Research Foundation and, more recently, a charter member of the new IASB, the so-called "McGregor Report" roundly criticized SFAS No. 13 and the lease accounting standards of the other G4+1 member organizations. According to McGregor (1996), current standards fail to account for the assets and liabilities associated with the rights and obligations that arise out of most "operating" lease contracts. McGregor (1996, 13)...

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