8(c). Accounting for Leases and Other "Executory" Contracts
[Context] The following brief summary of the topic "Accounting for Intangible Assets," is from the "Executive Summary" of the report the AIMR's Financial Accounting Policy Committee (FAPC):
Current accounting for intangible assets has great potential for confusion. Purchased intangibles are initially recorded at cost and amortized over periods of time that often are arbitrarily determined. Self-developed intangibles are for the most part not recorded. Financial statement comparability between and among enterprises suffers accordingly. Our contemplation of this situation leads us to two major recommendations that we believe will increase comparability. Both recommendations are controversial and should be considered in the light of the full discussion of them in the report. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. viii]
First, we advocate capitalization of all executory contracts with an initial duration of more than one year. We would include not only leases, but also employment agreements and similar contractual arrangements. Our recommendation does not advocate any change that would weaken the standards governing revenue recognition. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. viii]
Second, we recommend that purchased goodwill will be written off at the date it is acquired. We believe that it is an important number, but only to depict a value at a particular date, a value that undoubtedly is subject to rapid and sizable change thereafter. We cannot see how its presence on the balance sheet is of use in estimating a firm's future cash flows or gauging its contemporaneous value. Therefore, we recommend banishing goodwill from an enterprise's list of assets, but preserving a record of it by having it show as a separate and distinct reduction of shareholders' equity. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. viii]
[Context] It indicates the scope of the discussion of the topic and lists the report's major recommendations, providing an introduction to the following excerpts from the report.
An earlier part of this report, [pp. 17 and 18, quoted in 7(b)] discusses implications for financial reporting of the rise in the proportion of economic activity attributable to the service sector. One ramification is its exacerbation of the persistent and vexing question of how to account for intangible assets. Service businesses are, with certain notable exceptions such as telecommunications, generally labor intensive. These firms have few tangible assets and in many cases have balance sheets that under conventional accounting show meager or even negative owners' equity. In fact, however, they may possess sizable unrecorded economic resources in the form of anticipated future cash flows. Yet, under traditional accounting methods, the value of those future cash flows is recorded only when: (a) they are acquired in a purchase transaction with an unrelated party, or (b) the anticipated cash finally is received. On the other hand, equity investors and lenders are forced to acknowledge the value of future cash flows in order to make sensible investment and lending decisions in competition with other rational suppliers of capital. Our views on this matter are set forth below. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 29]
Nature of the Problem
All economic value must ultimately result in cash inflow(s). In fact, it is future cash flows to which both equity investors and lenders look for a return on and return of their investments. Tangible assets offer an additional measure of comfort in that they usually but not always have some value at liquidation even though it may be modest. Furthermore, tangible assets are, without significant exception, acquired in exchange transactions with outsiders and, except for business combinations, are usually acquired individually or in groups of related items. Even when acquired in a basket purchase, it usually is not particularly difficult to obtain competent data to allow their values to be reported separately. Therefore, ordinarily there is little problem in recording at least the initial values of tangible assets. The same is true of intangible assets (patents, franchises, etc.) purchased separately. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 29]
Major problems arise with accounting for intangible assets that either are self-developed or acquired in a business combination. Other problems emanate from intangibles whose sole value comes from their ability to enhance the cash flows of a going concern. For example, how are analysts sensibly to compare two firms, one of which has developed strong brand names through sizable expenditures none of which has been capitalized (say, the Proctor and Gamble Company), the other of which has grown by purchasing the brand names of others (say, RJR Nabisco)? How are analysts to find useful the financial statements of cable television and other media firms that have significantly negative net worths because they have borrowed against future cash flows and used the proceeds either to cover reported losses or to make payments to stockholders?7 [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 30]
Sources of Future Cash Flows
Intangible assets comprise all sorts of contractual, institutional and informal arrangements, all of which are characterized by associated expectations of future cash inflows. Many of these values are attributable to human beings who are talented, well-trained, acculturated, or otherwise able and willing to contribute to the enterprise's economic well-being. Arrangements between the firm and its employees vary. Some, mainly senior managers and others who make unique contributions, serve under individual contracts. Some of those contracts may contain provisions that activate sizable payments at or after the individual's separation from the firm, so-called "golden parachutes" and similar arrangements. At the other end of the scale are collective bargaining agreements with unions and other worker organizations. In between are the ordinary day-to-day, month-to-month continuances of employment and service. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 30]
Future cash flows may also be attributed to franchises. That term is used in its broadest sense to include not only contractual arrangements, but also other exclusive accesses to customers. A brand name might be said to be a "franchise." For example, one thinks of the position of the Campbell name in canned soup, H.J. Heinz in ketchup or Bayer in aspirin. Anther example of an exclusivity is a long-established reputation, such as those carried by the "Big Six" accounting firms, certain major law firms, advertising agencies, actuaries, consultants and a host of other professional services providers. Health care organizations are very likely to have franchises arising from both their reputations and their proximity to patients. A news distributorship in Manhattan, New York City, is worth more than one in Manhattan, Kansas. The examples could go on and on. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 30]
In many cases expectations of future cash flows may dissipate in the face of competition and are able to continue to flourish only if the enterprise continues to support them with attention and expenditures. Alternatively, exclusive rights may be obtained either under law (patents, copyrights, trademarks, etc.) or by contract. An enterprise may contract for a franchise (in the narrow sense of the word) for human services, for services to be provided by another organization, or for the rights to use real assets (plant and equipment) for limited periods of time. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 30]
All of the above are intended to be an illustrative but not exhaustive list of the incredible variety of sources of intangible value. All of them illustrate cases of valuable assets that, with two exceptions, are not recorded. One exception is when the asset is purchased in an arms-length exchange transaction. The other exception is for certain lease agreements that meet one of the conditions that qualify them as capital leases. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 31]
Contractual Arrangements
Contractual arrangements are quite opposite from goodwill. We refer here to what are commonly called executory contracts, those awaiting performance by both parties[*]. With the exception of capital leases, executory contracts are not recorded in financial statements and are disclosed only when they are material and out of the ordinary course of business. We have observed the machinations that often accompany the classification of lease agreements. We also are overwhelmed by the excessive volume of extremely detailed accounting definitions, procedures and rules designed to foil such intrigues. [AIMR/FAPC92, p. 31-32]
We suggest a standard that would be far simpler but broader in its application. We would require capitalization of all executory contracts with an initial term in excess of one year. That would eliminate many of the problems attendant on lease accounting. More importantly, it would place on the balance sheet at least some of the quite real intangible assets that do not now appear. For example, in the case of King World Productions (see footnote 7) it would allow recording as assets contractual rights with television stations with a corresponding liability to produce programming in the future.9 We see that as not significantly different from capital lease accounting. We believe that employment contracts with executives and key employees also should be capitalized, even if performance cannot be compelled. If the employee resigns, the remaining equal amounts of intangible asset and obligation to pay wages would be removed from the balance sheet. If the employee is discharged, the remaining intangible asset would be a loss to the extent that the enterprise continued to be liable either for future compensation to the employee or for a settlement. [AIMR/FAPC92, p. 32]
Costs to Create Intangible Assets
We are not enamored of recording self-developed intangible assets unless their values are readily apparent. We consider the cost of creating them to be so often unrelated to their actual value as to be irrelevant in the investment evaluation process. Furthermore, it usually is next to impossible to determine in any sensible or codifiable manner exactly which costs provide future benefit and which do not. For example, even though we would record the contractual amounts of employment agreements, we would not go so far as to capitalize the costs of training and developing human resources. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 32-33]
We cannot quarrel with capitalization of the costs of intangible assets that are purchased. In that case, the cost is the value of the asset: no heroic or outlandish assumption is required. However, to approach comparability with firms that have created similar intangibles with their own resources, we recommend amortization of the purchased variety over economic lives that we expect will be short. In most cases a purchased intangible will maintain its value only if it is tended and cared for by the type of expenditures that create self-developed ones. A better way of looking at it is that if the purchased intangible is not maintained, it will be exhausted quickly not to be replaced by a self-developed one. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 33]
We reiterate our strong feeling that goodwill should not be recognized except briefly and only when it is determined by the exchange price for an entire enterprise. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 33]
The Importance of Cash Flows
The discussion above makes it clear that intangible assets derive their value from the prospects they engender for future cash flows and that it is difficult or impossible in many cases to obtain a sufficiently reasonable measure of their value to place on the balance sheet. Therefore, it is important in extremis for financial reports to disclose clearly the amounts and sources of past cash flows. The ultimate test of the value of an intangible asset is whether or not it contributes to the stream of cash entering the firm. This is exactly the reasoning implicit in FAS 2, "Accounting for Research and Development Costs." Because the expectation of future benefits from research expenditures is so uncertain, their value cannot be recorded in advance. We must wait until they are received in cash. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 33]
Not only do we have to know the source of cash flows from intangible assets in detail, we also have to know how likely it is that they will continue and at what rate. While the flows continue we need to know what is being done with them. Are they being distributed or reinvested? Are the reinvestments in kind or are they a divergence from past practice? Much of the needed cash flow information requires both disaggregation of historic data and candid management discussion of the future. We speak later in this report at greater length about other aspects of the usefulness of the cash flow statement. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 33]
Conclusions about Intangible Assets
Our overall conclusion on intangible assets can be summarized as follows. It is an area fraught with difficult conceptual and implementation problems and we do not have a monopolistic position with respect to their solutions. However, we believe that financial reporting can be modified so as at least to recognize more of the economic reality of intangible assets than it does now. We recommend the following: [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 33]
1. Assets and liabilities should be recognized for the present values of future cash flows when: (a) they are the result of contractual arrangements, and (b) the cost of providing the service does not directly determine its selling price.
2. Goodwill should not be recognized except briefly as it is determined by the exchange price for an entire enterprise because: (a) its determination (except at the rarely-encountered moment of an exchange) is the stuff of financial analysis, not accounting, and (b) its value at that moment is fleeting and has no necessary or causal relationship to its value in the future.
3. Reserve recognition accounting should be reconsidered, supported by adequate prior research.
4. Past cash flows are extremely important and should be reported in terms of: (a) their source, (b) the likelihood of their continuance, and (c) the means to replace them when it becomes necessary. [Also included in 7(a) and 7(b)] [AIMR/FAPC92, p. 34]
[Context] The AIMR report's introduction to the section entitled "Summary of Important Positions and Guide to Future Actions" begins and ends as follows:
Much of this report relates to the present state of the art and implications for future developments in financial reporting. Righfully, so do most of the positions stated in this section . . . [T]hey all build on positions taken by AIMR in the past . . . [Also included in 1(b), 1(d), 3(d), 4, 5(a), 11(a), 12, 18(a), 18(c) and 18(d)] [AIMR/FAPC92, p. 59]
We expect the positions set forth below to build on the precedents of the past. That does not prevent them from breaking new ground, but they do not introduce significant inconsistencies with previous AIMR positions. To the extent that they do establish new stances those are largely the result of the changing world that we describe earlier in this report. [Also included in 1(b), 1(d), 3(d), 4, 5(a), 11(a), 12, 18(a), 18(c) and 18(d)] [AIMR/FAPC92, p. 60]
Those two paragraphs introduce the following summary of a position taken by the Committee.
Recognize All Executory Contracts
We all have struggled to understand the immense body of detailed rules that govern accounting for leases. Sometimes it seems as if the only persons having sufficient motivation to study their particulars are those who need to write lease contracts that produce desired outcomes. We know that the criteria for distinguishing between capital lease and operating lease set forth in FAS 13 and its supplements are arbitrary and their application often is willfully capricious. Sometimes it seems as if the opportunities to manipulate the rules are in direct proportion to their copiousness. [Also included in 1(d)] [AIMR/FAPC92, p. 62]
We believe the rules could be simplified. First, we would drop the current dichotomy between accounting standards for leases and those for other executory contracts. We would have them treated in the same way. Second, we believe that financial reporting would be improved considerably if all executory contracts of more than one year duration were to be capitalized. That would result in the recognition of all receivables and payables at the present value of future legally enforceable commitments to exchange cash in the future. Our reasoning is set forth earlier in this report. [Also included in 1(d)] [AIMR/FAPC92, p. 62]
__________
[Context] Meeting of the Investor Discussion Group on October 16, 1992. When discussing the types of information they use to achieve their objectives, investors were asked specifically about current accounting alternatives for leases.
Committee/Staff/Observer
What about leases? There are capital leases and operating leases; do you capitalize operating leases? Do you make adjustments? [Also included in 1(b)] [TI 10/16, p. 38]
Participant I-9
Anything you can do to work operating leases and capital leases together would be constructive from the standpoint of somebody who doesn't have the inside information of the person doing the leases, because it's almost impossible to reconcile what the financial statements say with what is actually going on in the business under the present system. [Also included in 1(b)] [TI 10/16, p. 39]
Participant I-1
If you have one accounting treatment for all leases, you need to get more disclosures as to the nature of the leases. For example, in terms of termination; a 5 year lease is not a 5 year lease for everyone, you might have more flexibility to get out of the lease obligation in some circumstances. [TI 10/16, p. 41]
Participant I-3
I don't make the adjustment very often because I don't have the information, but I would like to see the information about long-term contracts (1 or 2 years) entered into by companies that sell commodities. In one or two years, commodity prices can fluctuate a great deal and if a company is locked in at a particular price for a meaningful % of their potential output, I would like to know that because it changes the way you think about the revenue in the future and it is important. Even a footnote would be very useful. [Also included in 1(b)] [TI 10/16, p. 41-42]
[Context] Meeting of the Investor Discussion Group on December 9, 1992. Part of the meeting was devoted to the topic of alternative accounting procedures. Comments were made on accounting for leases.
Committee/Staff/Observer
Changing the topic to leases, would you favor a change in practice to require capitalization of all leases, assuming that they're leases with a term extending beyond the balance sheet date? [TI 12/9, p. 49]
Participant I-11
I don't. I have the same position on that than I do on business combination accounting. In fact, I'm not totally comfortable with capitalized leases since it has created a couple of artificial items on the balance sheet. [TI 12/9, p. 49]
Committee/Staff/Observer
What kind of artificial items? [TI 12/9, p. 49]
Participant I-11
The imputed value of the lease is an artificial value (using an implicit interest rate). [TI 12/9, p. 49]
Committee/Staff/Observer
We are lead to believe that in some industries, like in retailing and the airplane industry, analysts regularly convert operating leases into capital leases as part of their analysis. Would that be correct? [TI 12/9, p. 49]
Participant I-9
I would like to see one common accounting method for leases. What bothers me with capital leases is when, for example, you have a company that enters into a $10 million lease and then it appears as debt of $7.5 million on the balance sheet. Intellectually, I can understand that but it still bothers me. The problem is that the number is not relevant if you're in a distressed situation because a company can get out of a lease obligation in some circumstances. [TI 12/9, p. 49]
Participant I-6
I think that just full disclosure of the obligation under the lease agreement is more meaningful than the way the leases are accounted for on the balance sheet. [TI 12/9, p. 49]
Participant I-4
I agree with [participant I-6] it's more important to have full disclosure than to account for the lease in a specific way. [TI 12/9, p. 50]
Participant I-12
From a lessor's point of view, I always felt uneasy about the accounting for residual values; not enough information is provided about them. [TI 12/9, p. 50]
Participant I-6
Leases are a perfect example of things you could get rid of in the balance sheet and just put in the footnotes. This is one area where you could simplify. [TI 12/9, p. 50]
Committee/Staff/Observer
Would you suggest that we have every lease as an operating lease coupled with footnote disclosure of the terms of the lease and the cash flows? Is that what you mean by simplify? [TI 12/9, p. 50]
Participant I-6
Yes. [TI 12/9, p. 50]
Committee/Staff/Observer
You're saying: "capitalize no leases"? [TI 12/9, p. 50]
Participant I-6
Correct. [TI 12/9, p. 50]
Participant I-4
I would definitely prefer to have all leases treated as operating leases, with disclosure, rather than capitalized leases. [TI 12/9, p. 50]
Participant I-9
I have to say that capitalized leases are the answer in retailing; you can't have a retail balance sheet without capitalized leases because the alternative is a mortgage. [TI 12/9, p. 51]
[Context] Meeting of the Investor Discussion Group on January 13, 1993. Part of the meeting was devoted to the topic of value information. During the discussion, an investor made a reference to accounting for leases.
Participant I-14
Covering a broad range of industries over a long period of time, I would agree with [participant I-11] more than anyone I heard around here. I think you need a sense of stability somewhere. I think notional comments about fair value would be helpful but it can't eliminate the analyst's judgment. Fair value changes often enough. One of my favorites is lease accounting; I started when leases were a liability, and in the 1980s I was told they were assets, now they seem to be liabilities. Comments by management in footnotes would be helpful. [Also included in 4] [TI 1/13, p. 7]
[Context] Meeting of the Creditor Discussion Group on December 8, 1992. Part of the meeting was devoted to the topic of creditors' objectives and approaches. During the discussion, comments were made on accounting for leases.
Participant C-1
We generally adjust for as many non-cash charges as we can determine. Amortization, depreciation, ESOP expenses, SARs. Some companies are more user friendly than others in disclosing specifically what those are. Non-recurring items: selling a division, strikes, if possible. Generally, management is telling you why their numbers are so poor because it's some sort of non-recurring number. Operating leases, depending on the type of company and on the magnitude of the operating leases. And the adjustment process is trying to work into intrinsic value. Most of the types of companies that we look at don't have pension plans so we don't have to worry about it. Environmental liabilities and litigation risk is one of the things we spend a lot more time looking at. That's something you get more from management. [Also included in 1(b)] [TC 12/8, p. 45]
__________
Committee/Staff/Observer
[Participant C-1] mentioned operating leases and adjusting for operating leases. Do others adjust for operating leases? And can you tell us a little bit about what you do and what you try to accomplish? [Also included in 1(b)] [TC 12/8, p. 47]
Participant C-5
We adjust them back as if they're capitalized leases, for retailers, in particular. It's industry by industry. Transportation, as well. [Also included in 1(b)] [TC 12/8, p. 47]
Committee/Staff/Observer
So you're capitalizing the operating leases? [Also included in 1(b)] [TC 12/8, p. 47]
Participant C-5
Yes, for analysis purposes, for leveraged calculations as well as interest cover, too. We would look at our interest cover based on a lease. [Also included in 1(b)] [TC 12/8, p. 47]
[Context] Meeting of the Creditor Discussion Group on February 2, 1993. Part of the meeting was devoted to the topic of display.
Committee/Staff/Observer
Again, here's two choices. A lease can be structured to be an operating or a capital lease. It is a form test. Which means that a transaction can be structured a certain way, get a certain kind of accounting. The question is whether or not accounting should ordain one method of accounting for all leases? [TC 2/2, p. 46]
Participant C-17
If I'm an equipment lessor and you kill operating leases, you kill me. [TC 2/2, p. 46]
Participant C-15
I'll use the airline industry as an example. Companies like [names deleted], provide leases to airlines; those are for one year or two years, three years, for a limited period of time. And that's all that the obligation for the airline is. As opposed to a financing lease which is a 25 year obligation. To have the same accounting for both would seem to me to not do justice to the flexibility that the company would have from entering into operating lease. [TC 2/2, p. 46-47]
Participant C-17
The issue for me with operating leases is: what is the company's real liability, because, for instance, in an equipment lease, if it's a five year term and they go into liquidation or bankruptcy, what ever else, I can prove that it's a new lease. That lessee is responsible to me for the full value of my rents. And that's a real liability he has. If it's a real estate lease, the liability may be for a year or I think it goes up to three years. So when I'm trying to evaluate how leveraged that company is, with debts that are not showing up on the balance sheet, I don't feel that I have a very good handle on how to do it. The only thing I can do is sit there and say, I don't know what it is on the present value basis; I just sum everything and say, well, potentially he's going to have to pay $12 billion and maybe not. [TC 2/2, p. 46]
Participant C-5
Maybe this is not a question of two choices but that the form test is not the right form test. [TC 2/2, p. 47]
Committee/Staff/Observer
What would be the right criteria? [TC 2/2, p. 47]
Participant C-5
Twenty-five year lease I'm pretty clear, it's a capital lease regardless of what. Five year is less clear. [TC 2/2, p. 47]
Participant C-15
That's probably right in the middle of gray; five years. [TC 2/2, p. 47]
Committee/Staff/Observer
Well, five year with four renewal options? [TC 2/2, p. 47]
Participant C-5
Yes. [TC 2/2, p. 47]
Committee/Staff/Observer
Going back to what you do as users, facing this multi-headed lease monster. I think [participant C-17] is saying that he has got a problem and he's not able to completely solve it with simply writing it off the balance sheet against the equity section like we've done with goodwill. [TC 2/2, p. 48]
Participant C-17
I'm saying that the footnote liability may not, in fact, be the true legal liability that that particular company has because of the adjustments that can occur. [TC 2/2, p. 48]
Participant C-5
He's talking default liability. I'm worried about fixed charge coverage and future periods and so forth. I'm not worried about an acceleration in all cases. [TC 2/2, p. 48]
Committee/Staff/Observer
So do you make that adjustment? [TC 2/2, p. 48]
Participant C-5
Yes, we add them back and treat them as capital. [TC 2/2, p. 48]
Committee/Staff/Observer
Where's your cut when you look at an operating leases? [TC 2/2, p. 48]
Participant C-5
I think it's industry convention. There are certain industries you automatically adjust back for, and other industries you don't. [TC 2/2, p. 48]
Participant C-11
I tend to try to capitalize, put it on the balance sheet. But I admittedly don't know all the nuances of these two year, three year things. [TC 2/2, p. 48]
Participant C-15
I think the way I'm trying to deal with a short-term lease, is to capitalize it, doing some kind of sensitivity analysis as to options to roll it over. But if you assume a going concern for an airline, for example, they'll need those airplanes, and those are really like fixed charges almost. So we capitalize them and see what impact they have on their capital structure. [TC 2/2, p. 48]
Committee/Staff/Observer
I'm not convinced that I've heard a clear indication of whether or not that means that the accounting should all be the same way. [TC 2/2, p. 49]
Participant C-17
From my own opinion, that's true. Companies enter into financial arrangements for more than just accounting; there are true economic benefits. [TC 2/2, p. 49]
Participant C-5
I would agree with that. I'm not so sure the current test finds the right break. [TC 2/2, p. 49]
Participant C-4
As long as we get the information we can make the adjustments and analyze the effects. [TC 2/2, p. 49]
[Context] Responses to the postmeeting questionnaire to the February 2, 1993 Creditor Discussion Group.
QUESTION 11-Lease Accounting Methods
With respect to alternative methods of accounting for leases-
Please indicate your preference with 1 meaning most preferred, 2 meaning next preferred, and so on to 5 meaning least preferred (use a number only once).
1-6,2-1,3-3,4-3,5-1 All leases other than month-to-month leases and leases whose terms do not extend past the balance sheet date should be capitalized
1-1,2-0,3-2,4-4,5-5 All leases should be accounted for as operating leases
1-4,2-5,3-3,4-1,5-0 Some leases should be considered operating leases, while others should be capitalized. Please indicate whether you S-Strongly Agree, A-Agree, or D-Disagree with each of the following:
SA-2,A-4,D-4 Operating leases should be the exception, not the rule
SA-2,A-6,D-3 Some leases should be operating leases, while others should be capitalized. The difference depends principally on the lease period
SA-0,A-4,D-7 Some leases should be operating leases, while others should be capitalized. The difference depends principally on the type of asset being leased
SA-2,A-1,D-2 Some leases should be operating leases, while others should be capitalized. The difference depends principally on (please describe)
Participant C-17: Economic risk-who bears it as an indication of true ownership.
Participant C-15: Economically, intention to renew.
Participant C-18: Whether or not the lease substantially uses up economic life of asset leased.
Participant C-2: Whether ownership transfers at end of period.
Participant C-4: The materiality of the current lease payments - base on percent of current liabilities.
1-3,2-7,3-0,4-2 The problem with lease accounting lies less in whether or not they are capitalized and more in the fact that the following disclosures are missing or inadequate. Please indicate whether you S-Strongly Agree, A-Agree, or D-Disagree with each of the following:
SA-5,A-5,D-2 Lease obligations need separate disclosure by type of asset (e.g., real estate, major operating assets, tangible personal property, etc.)
SA-3,A-7,D-2 Lease obligations need disclosure of maturities (i.e., grouping separately leases with short, medium, and long terms)
SA-2,A-5,D-5 Lease obligations need to be distinguished by separating obligations representing inescapable future cash payments from obligations which in, say, bankruptcy would only extend a limited time regardless of the specified lease term
SA-1 Other. Please describe
Participant C-14: PV of operating leases could substitute for capitalization.
1-0,2-0,3-4,4-2,5-6 Lease accounting should eliminate operating lease alternatives, at least for some assets, but the determination should be specified on an industry-by-industry basis
[PMQC 2/2, p. 19-21]
[Context] Meeting of the Creditor Discussion Group on March 11, 1993. Part of the meeting was devoted to the topic of priority of improvements needed in external reporting. During the discussion, comments were made on accounting for leases.
Committee/Staff/Observer
I have a specific question on 13 which is accounting for financial instruments including off balance-sheet-financing. Those who ranked that in the top three, did you include off-balance-sheet leases or weren't you thinking about it? [Also included in 15 and 19] [TC 3/11, p. 74]
Participant C-11
Not in the same context. For different reasons, I think this classifies as off-balance-sheet. I think they're very different risks. [Also included in 15 and 19] [TC 3/11, p. 74]
Committee/Staff/Observer
So would you also encompass in 13 changes in accounting or information about off-balance-sheet leases? [Also included in 15 and 19] [TC 3/11, p. 75]
Participant C-11
I think it should be on balance sheet myself but ...[Also included in 15 and 19] [TC 3/11, p. 75]
Committee/Staff/Observer
But the reason is not because of the qualitative questions you had with respect to everything else that's off-balance-sheet? [Also included in 15 and 19] [TC 3/11, p. 75]
Participant C-17
I don't think anybody's mystified about what an operating lease is all about. I think there's a great deal more esoteric around the hedging situation. I'm not certain that the management itself always has the sophistication or focus that they ought to. [Also included in 15 and 19] [TC 3/11, p. 75]
[Context] Responses to the postmeeting questionnaire of the December 9, 1992 and January 13, 1993 Investor Discussion Group meetings.
QUESTION 17 - Lease Accounting Methods
With respect to alternative methods of accounting for leases-
capital lease method, which results in the recognition of an asset and a liability by the lessee
operating lease method, which does not result in the recognition of an asset and a liability by the lessee, but rather by the recognition of a rental expense as the cash payments accrue on the lease-
Please indicate your preference with 1 meaning most preferred, 2 meaning next preferred, and so on to 5 meaning least preferred (use a number only once)
1 2 3 4 5 All leases other than month-to- month leases and leases whose terms do not extend past the balance sheet date should be capitalized 1 1 1 1 All leases should be accounted for as operating leases 2 2 Some leases should be considered operating leases, while others should be capitalized. Please indicate whether you S—Strongly Agree, A Agree, or D Disagree with each of the following: 2 1 Strongly agree Agree Disagree Operating leases should be the exception, not the rule 1 1 2 Some leases should be operating leases, while others should be capitalized. The difference depends principally on the lease period 1 2 Some leases should be operating leases, while others should be capitalized. The difference depends principally on the industry and/or the type of asset being leased 3 Some leases should be operating leases, while others should be capitalized. The difference depends principally on the amount of lease payments relative to the value of the leased asset 3 Some leases should be operating leases, while others should be capitalized. The difference depends principally on (please describe) 2 The problem with lease accounting lies less in whether or not they are capitalized and more in the fact that the following disclosures are missing or inadequate. Please indicate whether you S—Strongly Agree, A—Agree, or D—Disagree with each of the following: 1 1 1 Strongly agree Agree Disagree *Lease obligations need separate disclosure by type of asset (e.g., real estate, major operating assets, tangible per sonal property, etc.) 2 3 *Lease obligations need disclosure of maturities (i.e., grouping separately leases with short, medium, and long terms)2 3 *Lease obligations need to be distinguished by separating obligations representing inescapable future cash payments from obligations which in, say, bankruptcy, would only extend a limited time regardless of the specified lease term 3 1 1 * Other. Please describe Participant I-11: Disclosure by type of asset with maturity information also disclosed by type of asset. 1 2 3 4 5 Lease accounting should eliminate operating lease alternatives, at least for some assets, but the determination should be specified on an industry-by-industry basis 2 1 1 1 Participant I-12: Lease accounting is difficult: the key issue to me is the "capital" aspect. In essence, companies are renting capital equipment for a whole variety of reasons (obsolescence, financial and tax incentives, etc.) What about the lessors? Theie leasing assets are generally viewed as "loan" equivalents. If lessees are capitalizing leases, it would seem that lessors should treat leases comparably. Since I'm not as familiar with the details of lease accounting, it seems like there are a number of issues that need more discussion [PMQI 12/9 and 1/13, p. 32-34]