FASB and IASB Decouple Lease Accounting and Reporting for Investment Property
On June 13, NAREIT observed the joint meeting of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (collectively, the Boards) that focused on lease accounting (see Agenda Paper 3) in London, UK. NAREIT member companies operating as equity REITs will be particularly interested in the Boards’ revised approach to lease accounting.
The Boards revised their approach to both lessee and lessor accounting to address constituent views that there are more than one type of lease and that they should be accounted for differently. While the Boards reaffirmed that lessees should recognize lease obligations on their balance sheets, the Boards revised the expense and income recognition pattern on the income statement for both lessees and lessors depending on the nature of the underlying asset. Based on the Boards’ tentative decisions, NAREIT believes that, for most property leases, lessors would recognize lease revenue on a straight-line basis and lessees would recognize rental expense on a straight-line basis. This income statement recognition for most property leases by both lessors and lessees would mirror current reporting. Most leases of assets other than property would result in a front-ended income (for lessors) and expense (for lessees) pattern. NAREIT has been advocating straight-line income statement recognition for lessors and lessees of real estate since the project began nearly six years ago.
Leases of property, which is defined as land or building, or part of a building, or both, 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.
Leases of assets other than property (e.g., automobiles, copiers, fax machines) having terms of more than 12 months would be accounted for under the approach proposed in the 2010 Leases exposure draft. These leases would be accounted for as financing transactions, which would result in front-loading expense by lessees 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.
Given the decisions reached on lessee accounting, the Boards agreed to revisit previous decisions with respect to lessor accounting. The Boards agreed that symmetrical accounting as between lessees and lessors is most appropriate, and therefore decided to draw a distinction between leases of property and leases of assets other than property, similar to conclusions reached for lessee accounting. In so doing, the Boards reversed an October 2011 tentative decision that explicitly exempted lessors of investment property from the receivable and residual lessor accounting model. Depending on the terms of the lease in relation to the nature and economic characteristics of the underlying asset, the income recognition pattern could be either straight-line or be based on the Boards’ proposed receivable and residual model. As indicated above, NAREIT believes that rental income for most property leases would be reported on a straight-line basis.
It is unclear what impact, if any, these decisions with respect to lessor accounting might have on the FASB’s Investment Property Entities Project. NAREIT understands that the FASB intends to make a decision on the future of the project in July 2012. The Board’s options with respect to this project include:
Continue to develop an entity-based standard for reporting investment property;
Develop an asset-based standard under US GAAP similar to International Accounting Standard No. 40 Investment Property; and
Provide guidance for accounting and reporting for investment property under the Board’s proposed Investment Companies standard.
NAREIT has made its position with respect to reporting investment property clear to the Board that, if the FASB and IASB are not prepared to initiate a formal project to consider aligning accounting and reporting for investment property under U.S. GAAP with IAS 40 or a similar asset-based converged standard (with an option to report investment property at either fair value or historical cost), NAREIT believes that the FASB should take no further action with respect to reporting investment property at fair value for U.S. REITs and operating real estate companies.
The Boards plan to conduct one final decision-making meeting on lease accounting in July 2012 before moving to drafting of the second exposure draft. The Boards intend on issuing the exposure draft by the end of 2012 with a 120 day comment period, and issue a final standard by mid 2013. NAREIT expects that the effective date for the final standard would be no sooner than 2016.