The Lease Line

ACCT352 Research Case-Fall 2020

The Lease Line

Objectives

• To understand the differences between lease classification under ASC840 and ASC842.
• To expose you to the fundamental arguments for and against each approach.
• To think critically about the relevance and appropriateness of “bright line” accounting policies.
• To provide you an opportunity to demonstrate and improve upon your communication skills.
• To develop an opinion and articulate it.

Background

Leasing transactions represent a very significant portion of the capital investments of many companies. The accounting classification of these leases can have a dramatic impact on the financial position and earnings reported by a company. The AICPA Accounting Trends and Technique – 2010 disclosed that 488 of the 500 companies surveyed (98%) had leases. During the early 2000s, a resurgence of interest in off-balance sheet financing took place in the economic environment, which placed a premium on asset return and return-on-equity ratios. This same interest continues today as companies contemplating financing often view the benefits of off-balance sheet accounting as a major factor in deciding whether to consummate a proposed lease.

For many years, there have been concerns raised stating that the ASC840 lease accounting model is inadequate, the leasing standard has often been criticized as being too reliant on bright lines and subjective judgments. Many believe that such reliance has led entities to account for economically similar transactions differently and has presented opportunities for entities to structure transactions to achieve a desired accounting effect. Such criticism prompted the SEC — in its 2005 report on off-balance-sheet arrangements — to recommend that the FASB undertake a project on lease accounting.

The FASB issued the ASU 2016-021 (codified in ASC 842) on February 25, 2016, and focused on implementation efforts related to the adoption of ASC842.The primary objective of the leases project was to address off-balance-sheet financing concerns related to lessees’ operating leases. ASC842 will require lessees to recognize most leases on their balance sheets as leased liabilities with corresponding right-of-use assets. This change will affect a large number of companies, with the U.S. Securities and Exchange Commission (SEC) estimating that companies have approximately $2.3 trillion in operating lease commitments.

There are basic differences in determining the classification of a lease as either an operating lease or a capital/finance lease when comparing ASC840 and ASC842. ASC840 uses a bright line approach whereas ASC842 uses a conceptual, principles-based approach. Consequently, it is quite possible to achieve a different accounting result for a lease classified as operating or capital/finance, depending on which accounting standard is being used.

One industry that relies heavily on off-balance sheet financing through leasing is the airline industry. A significant proportion of aircraft utilized by major airline carriers is financed under operating leases. This practice is not just in the US but also abroad. Below is an overview of some of these airlines and the percentage of their aircraft that is classified as off balance sheet via operating leases as obtained from 2013 company reports.

Requirements

• Review Subtopics 10 through 30 of ASC 840 and ASC842, Leases.
• Obtain Delta Airlines, Inc.’s, Form10-K for the fiscal year ended December 31, 2013. Review the financial statements and the footnotes pertaining to leases. Use the following link:http://deltaairlines.q4cdn.com/bdbbb545-aa88-4b7b-b4d4-9c892c1367ee.pdf
• Collins, D.L., W. R. Pasewark, and M. E. Riley. 2012. Financial Reporting Outcomes under Rules-Based and Principles-Based Accounting Standards. Accounting Horizons 26 (4), 681-705.

Based on the reference material mentioned above, answer the following questions:

1. What are the advantages and disadvantages of the ASC840 bright-line approach versus the ASC842 conceptual approach in determining the classification of a lease?
2. With regard to the potential change to account for most leases on the balance sheet under ASC842, provide the following:

What would be the impact on the financial statements of Delta Airlines, Inc. if all its leases were required to be recorded on the balance sheet as recently adopted ASC842 (assume that Delta consumes more than an insignificant portion of its leased airplanes) ? Would this be an improvement in transparency?

Analyze the above and prepare a 1-2 page report (font 12 of Times New Roman; short answers with bullet points are encouraged) addressing the above questions