FASB on Recalculating Leveraged Leases

The board clarifies an important criterion regarding just when a lease must be reclassified.
Helen ShawJanuary 23, 2006

At last Wednesday’s meeting, the Financial Accounting Standards Board considered proposed changes to Statement No. 13, Accounting for Leases.

An existing provision in FAS 13 requires that a lease should be recalculated when a change in an important assumption affects net income. One such change would be to the timing of cash flows relating to income taxes generated by a leveraged lease. In that light, last July’s proposed staff position 13-a was potentially significant: It would require that after a leveraged lease is recalculated, if the change in the timing of cash flows modified the characteristics of the lease so it no longer qualified for leveraged lease accounting, then the lease should be reclassified. The debt would then be recorded gross rather than net, and the pattern of income recognition would change as well.

Most comment letters disagreed, however, and at last week’s meeting the board agreed that a company would not be required to reclassify a lease in such circumstances.

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“We had valid reasons in the draft for requiring it,” board member Leslie Seidman said at the meeting. She added, however, that the requirement seemed to be “inconsistent with the general premise of FAS 13 that you do not reconsider the classification unless there is a change in the terms” of the lease agreement. If FASB pursued the reclassification approach, Seidman also noted, there would be inconsistency and implementation issues to make it operational.

Separately, to further clarify FAS 13, the staff recommended and the board agreed that when a leveraged lease is recalculated, all assumptions should be updated to rely on the most current information. The board also decided against its original proposal that interest and penalties should be included in the recalculation. The proposal, which would have accounted for interest and penalties within leveraged lease accounting, would have affected the profitability of individual leases and, possibly, whether the leases would meet the criteria for leveraged-lease accounting treatment.

Comment letters also raised the issue of the threshold that should be used for recognizing tax benefits in a leveraged lease transaction — “probable” recognition, or “more likely than not.” According to FASB, there is no numerical definition of “probable” in the accounting literature, but as practice has evolved, it has become generally accepted as being between 70 percent and 75 percent. “More likely than not” is generally accepted at 50.1 percent.

Respondents expressed concern that when a company evaluated whether the tax position in its financial statements would be sustained upon audit, the probable-recognition threshold would be too high to meet. At last week’s meeting, the FASB staff and the board agreed that the threshold should be consistent with FASB’s policy on Accounting for Uncertain Tax Positions. In that project — which applies to Statement No. 109, Accounting for Income Taxes, and which is currently in draft form — the board recently lowered the threshold to “more likely than not.”

At last week’s meeting, regarding its project to reconsider the accounting for postretirement benefits including pensions, the board also discussed:

• Modifications to Statement No. 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits, as a result of the proposed recognition of the funded status of defined benefit plans in the balance sheet of the sponsor;

• The proposed effective date and method of transition;

• The length of the comment period for the proposed statement, which is expected to be issued in March.

At this Wednesday’s meeting, FASB will consider:

• The remaining two issues on proposed staff position TB 85-4-a, Accounting for Life Settlement Contracts by Investors. The board will focus on whether an entity should be required to disclose an actual versus expected mortality, as well as the average expected remaining term of the contracts.

• Issues raised by external reviewers on the October 21, 2005, working draft of the fair-value-measurements final statement, including the fair-value hierarchy, disclosures, and effective date and transition.

• Comment letters received on its exposure drafts of Business Combinations, and comments on its draft of Consolidated Financial Statements, Including Accounting and Reporting of Noncontrolling Interests in Subsidiaries.

• Disclosure requirements related to the election to subsequently measure a class of servicing rights at fair value.