Financial reporting

  Accounting standard setters have agreed on a lessee accounting approach, setting the stage for a lease accounting exposure draft in the fourth quarter this year.

FASB and the International Accounting Standards Board (IASB) previously agreed that leases should be recorded on the balance sheet, but have been debating the classification and pattern of expenses in the income statement. They voted to support a lessee accounting model with different lease-expense recognition patterns for different leases (with the exception of short-term leases.)

The decision and some related revisions to the lessor accounting model were described by the boards as the last substantive decisions to be made before they re-expose the lease accounting proposals. IASB Chairman Hans Hoogervorst said in a statement that the boards are now on track to complete the leasing project in 2013.

The dual expense-recognition approach holds that not all lease contracts are the same; therefore some should be treated as the purchase of a right-of-use (ROU) asset, which is financed separately.

Other lease contracts would be treated as payment for access to and use of the underlying asset over time. This approach would link the right-of-use asset and the lease liability through the lease term, according to board documents. The lessee would allocate the total lease payments evenly over the lease term, resulting in straight-line total lease expense. This would occur even if the pattern of lease payments is not equal throughout the lease term. The lessee would present the total payments as lease expense.

“On balance, we decided that leases that convey a relatively small percentage of the life or value of the leased asset should be recognized, evenly over the lease term,” FASB Chairman Leslie F. Seidman said in a statement.

In the right-of-use approach, the lease would be accounted for as a nonfinancial asset and measured at cost, less accumulated amortization. The combination of the amortization charge on the ROU asset and the interest expense on the lease liability would result in a total lease expense that would generally decrease over the term of the lease, in other words, a front-loaded expense pattern.

After voting on the dual expense-recognition approach to lessee accounting, the boards, meeting in London, turned to discussion of how to determine when the different recognition patterns should be applied. The boards ultimately supported two options applicable to lessees and lessors:

  • Determination based on whether the ROU asset represents the acquisition of a more than insignificant portion of the underlying asset.
  • Determination based on the nature of the underlying asset.

For equipment leases, the presumption would be that the lease is an ROU lease for lessees and a receivable and residual asset for lessors unless the lease term is an insignificant portion of the economic life of the underlying asset or the present value of the fixed lease payments is insignificant relative to the fair value of the underlying asset.

Real estate leases would be accounted for using a straight-line presentation in the income statement unless the lease term is for the major part of the economic life of the underlying asset or the present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset.

  The SEC has asked FASB to review elements of accounting for derivatives contracts designated as hedging instruments as part of FASB’s existing project on financial instruments, according to a letter posted on the SEC’s website.

Then-SEC Chief Accountant James Kroeker sent a letter to Dan Palomaki, co-chair of the Accounting Committee of the International Swaps and Derivatives Association, explaining the SEC’s position. Kroeker copied the letter to FASB Chairman Leslie Seidman and PCAOB Chairman James Doty.

FASB is revamping its financial instruments standards as part of an ongoing convergence project with the IASB. The SEC asked FASB to consider in its financial instruments project the accounting for a change in counterparties when a derivative contract is designated as a hedging instrument in a hedge relationship, Kroeker’s letter explained.

According to the letter, Palomaki had asked for Kroeker’s view on the accounting impact under U.S. GAAP of a novation of a bilateral, over-the-counter (OTC) derivative contract to a central counterparty on the same financial terms. Palomaki asked whether the novation of a derivative contract designated as an accounting hedge to a central party would result in the termination of the original derivative contract and associated hedge relationship, such that the use of hedge accounting subsequent to novation would require the designation of a new hedging relationship, Kroeker wrote.

Kroeker wrote that his staff would not object to a conclusion that the original contract has not been terminated and replaced with a new derivative contract, nor would his staff object to continuing hedging relationships when there is novation of a derivative contract to effect a change in counterparties to the underlying contract, providing that other terms of the contract have not been changed, in any of the following circumstances:

  • For an OTC derivative transaction entered into prior to application of the mandatory clearing requirements, an entity voluntarily clears the underlying OTC derivative contract through a central counterparty, even though the counterparties had not agreed when entering the transaction that the contract would be novated to effect central clearing.
  • For an OTC derivative transaction entered into after the application of the mandatory clearing requirements, the counterparties to the underlying contract agree in advance that the contract will be cleared through a central counterparty in accordance with standard market terms and conventions, and the hedging documentation describes the counterparties’ expectations that the contract will be novated to the central counterparty.
  • A counterparty to an OTC derivative transaction who is prohibited or expected to be prohibited by Section 716 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, P.L. 111-203, from engaging in certain types of derivative transactions novates the underlying contract to a consolidated affiliate that is not insured by the FDIC and does not have access to Federal Reserve credit facilities.

The letter is available at  

  FASB clarified its plans regarding requirements for specific qualitative disclosures and the definition of “financial institution” that will be included in the liquidity disclosures section of its Proposed Accounting Standards Update (ASU) on accounting for financial instruments.

The board decided that a reporting entity should provide any additional quantitative or narrative disclosure necessary to help financial statement users understand the entity’s exposure to liquidity risk and interest rate risk, according to a summary of board decisions posted on FASB’s website.

To accomplish that objective, FASB decided, a reporting entity should discuss the significant changes in timing and amounts, as reflected by proposed tabular disclosures, that occur from the last reporting period to the current period. Reasons for any changes and actions taken during the current period to manage the exposure must be discussed.

The board decisions summary is available at Conclusions reached at board meetings are tentative and may be changed at future board meetings.

FASB also decided to create a definition of the term “financial institution” to be used in the Proposed ASU that would use the basic premise that a financial institution intends to earn its primary source of income as a result of managing the difference between returns paid on its financial liabilities and returns received on its financial assets.

The board decided that entities or reportable segments that meet this definition, as well as those that provide insurance, should be required to provide the same disclosures.

Entities that carry substantially all assets at fair value with changes in fair value recognized in net income will not be required to provide the disclosures in the Proposed ASU that apply only to financial institutions.

FASB also made tentative decisions regarding how modified debt instruments should be considered within the “three bucket” model with regard to impairment. The board tentatively decided that an entity would use a credit impairment allowance measurement objective of “lifetime expected credit losses” for modified debt instruments in which the lender, because of the debtor’s financial difficulties, grants a concession to the borrower that the lender would not otherwise consider. These are known as “troubled debt restructurings” under U.S. GAAP.

In these circumstances, the board concluded, a modified debt instrument is a continuation of the existing instrument and would be evaluated for credit deterioration in accordance with the instrument’s original concerns.

FASB is jointly conducting the accounting for financial instruments project with the IASB in an effort to create converged standards.


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