Re: File Reference No , Comment Letter on the Proposed Accounting Standard Update (revised): Leases (Topic 842)

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1 September 13, 2013 Tyco International Victor von Bruns-Strasse 8212 Neuhausen Switzerland Tel: Fax: Russell G. Golden, Chairman Financial Accounting Standards Board 401 Merritt 7 PO Box 5116 Norwalk, Connecticut Hans Hoogervorst, Chairman International Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom Submitted via electronic mail to director@fasb.org Re: File Reference No , Comment Letter on the Proposed Accounting Standard Update (revised): Leases (Topic 842) Tyco International Ltd ( Tyco ) appreciates the opportunity to respond to the FASB's Proposed Accounting Standards Update (revised), Leases ( revised exposure draft ). Tyco is a diversified publicly traded company that provides vital products and services to commercial and residential (outside the U.S.) customers around the world. We are a leading provider of security products and services, fire protection and detection products and services, and other industrial products. Tyco had 2012 revenue of more than $10 billion and has more than 70,000 employees worldwide. We acknowledge that the core principle of the proposed requirements is that an entity should recognize assets and liabilities arising from a lease as it would represent an improvement over the existing lease requirements. Overall, we continue to be supportive of the Boards efforts to improve lease accounting. However, we believe operational challenges continue to exist in the revised exposure draft. We do not agree with the proposal of identifying leases as either a Type A or Type B lease depending upon whether the underlying asset is property or other than property but rather suggest a more simplified alternative. Additionally, we do not agree with the inclusion of certain requirements in assessing whether an arrangement includes a lease (e.g., definition of a lease). We have included in Exhibit 1 our comments and suggested changes on the specific questions that were asked by the Boards. Thank you for your consideration. Sincerely, Sam Eldessouky, Senior Vice President, Controller and Chief Accounting Officer Safer. Smarter. Tyco. 1

2 Exhibit 1 Question 1: Identifying a Lease Do you agree with the definition of a lease and the proposed requirements in paragraphs through for how an entity would determine whether a contract contains a lease? Why or why not? If not, how would you define a lease? Please supply specific fact patterns, if any, to which you think the proposed definition of a lease, is difficult to apply or leads to a conclusion that does not reflect the economics of the transaction. Consistent with today s guidance of determining whether an arrangement contains a lease, the revised exposure draft requires assessing i) the identification of an asset and ii) the right to control the identified asset. However, the revised exposure draft introduces new concepts, specifically around defining when substitution rights are substantive and assessing the right of control. We believe these new concepts will be inoperable as written and therefore would appreciate additional guidance on the practical application of these concepts. If you are unable to provide additional guidance, we would then recommend you consider addressing the following two more specific issues. Identification of an asset In order for substitution rights to be considered substantive, the revised exposure draft highlights it must be feasible for a supplier to substitute the asset at any time without the customer s consent and without economic barriers. While the Basis for Conclusions clarifies that requiring a customer s consent to enter the customer s premises would not prevent the supplier from having substantive substitution rights, it is unclear whether the Board s expectation is that this right be explicitly defined within contracts. We believe it will be difficult to assess this requirement in those instances when it is not explicitly defined in a contract and a supplier rarely substitutes an asset in practice. In these instances, the supplier is clearly stated as the owner of the asset within the contract but rarely substitutes the asset in practice and therefore does not require such language in its contracts. We recommend the Boards consider removing the customer s consent as a condition for defining a substitution right as we do not believe it supports a substantive right, specifically in those situations where the asset is rarely substituted by the supplier. As highlighted within the Basis for Conclusions, some may insert a substitution clause within a contract to achieve an accounting outcome but it does not change the substance of the transaction; therefore, we believe the more meaningful measure of a substantive substitution right is whether the cost of substitution would be an economic disincentive. This is discussed in more detail in the next paragraph. As highlighted above, we believe the more meaningful measure of a substantive substitution right is the cost to substitute the identified asset. However, we recommend the Board s provide an illustration as to the practical application of whether substitution costs are so significant they create an economic disincentive for the supplier to substitute alternative assets. For example, some suppliers might evaluate whether costs create an economic disincentive based on whether they significantly affect the contracts margin whereas other suppliers might evaluate the same contract in terms of their absolute monetary value or as a percentage of the total contract cost. We believe that this is an area where diversity in practice could develop if further Safer. Smarter. Tyco. 2

3 clarification is not provided. The Boards should also consider incorporating a threshold to assist in defining what constitutes significant substitution costs. Alternatively, the Boards could include a customer s consent and economic barriers as considerations for whether a substitution right is substantive as opposed to required factors. Right to Control Identified Asset We understand the Boards attempt to create consistency between the revenue recognition and leasing projects; however, does the fact that a supplier or other suppliers sell the product separately provide a customer with the ability to derive benefits from the use of the asset and therefore the right to control the asset. As a result, we recommend this assessment be amended to not require the evaluation of whether the goods or services are sold separately by the supplier or other suppliers. Under the revised exposure draft, a contract conveys the right to control the use of an identified asset if the customer has the ability to i) direct the use of, and ii) derive benefits from, the asset throughout the term of the arrangement. The exposure draft was revised to include additional language addressing assets that are incidental to the delivery of services. As highlighted within the Basis for Conclusions, the Boards decided to clarify that when the use of an asset is an inseparable part of the overall services being provided to a customer, the customer does not obtain the right to control the use of the asset that is, the customer is unable to derive benefits from the use of the asset when the asset has no value or use to the customer without the other deliverables in the contract. Instead, the customer receives services over the term of the contract that requires the use of the asset. The revised exposure draft provides two conditions which would result in a customer NOT having the ability to derive benefits from the use of an asset. One of the conditions is that the customer can only obtain the benefit in conjunction with additional goods or services provided by the supplier AND these goods or services are not sold separately by the supplier or other suppliers. We reference back to the Boards February 2011 meeting where a cable box example was discussed. In the example of a supplier of digital television satellite services for certain television channels, the Board concluded such a contract would not contain a lease for the cable box provided because the cable box is incidental to the services requested by the customer. That is, the customer is not likely to care which cable box is provided, or whether a cable box is provided at all, as long as it has viewing rights to the specified television channels. However, we are not able to gather from the summary meeting minutes whether this example would meet the above condition newly added to the revised exposure draft. In any event, we do not agree that the cable box in this example would be considered a lease just because the cable box is sold separately by the supplier or other suppliers. We recommend the Boards consider including the cable box example within the exposure draft as an example of what is not a lease. Question 2: Lessee Accounting Do you agree that the recognition, measurement, and presentation of expenses and cash flows arising from a lease should differ for different leases, depending on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset? Why or why not? If not, what alternative approach would you propose and why? No, we do not believe the recognition, measurement, and presentation of expenses and cash flows arising from a lease should differ for different leases depending on whether the lessee is Safer. Smarter. Tyco. 3

4 expected to consume more than an insignificant portion of the economic benefits. We believe there is no similar concept elsewhere in existing accounting literature, in the conceptual framework or in corporate finance literature. We continue to believe a single leasing model will achieve the objectives of the Board to reflect all leases on the balance sheet. The differing models for different leases will create complexity resulting in unnecessary high costs to preparers without improving financial reporting. Under the revised exposure draft, to determine the aggregate income statement and cash flow effects of all lease contracts, suppliers would need to track expense and cash flow information for each type of lease (property versus nonproperty) as it may be provided in multiple and differing income statement and statement of cash flow line items. Refer to response in Question 4 below for further details. Question 3: Lessor Accounting Do you agree that a lessor should apply a different accounting approach to different leases, depending on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset? Why or why not? If not, what alternative approach would you propose and why? No, consistent with our response in Question 2, we believe a single leasing model should exist for both lessees and lessors. While we understand the Boards are attempting to create a dual model for lessee income/expense recognition and lessor accounting, we do not believe the current lessor accounting model is broken. Lessor accounting is focused on how the income from the lessor s investment should be recognized; while lessee accounting focuses on how the lessee s costs for using a specified asset should be recognized over the life of the arrangement. As the underlying objective in accounting for a leased asset differs between a lessee and lessor, we do not believe symmetry between the two is required. Therefore, we recommend the Boards retain the existing accounting guidance for lessors. This is further emphasized by the fact that the revised exposure draft will require lessors to account for the underlying asset rather than the conveyance of a right to use the underlying asset. The approach appears to be inconsistent with the overarching premise that lease accounting should be about right-of-use rather than the underlying assets. Question 4: Classification of Leases Do you agree that the principle on the lessee s expected consumption of the economic benefits embedded in the underlying asset should be applied using the requirements set out in paragraphs through 25-8, which differ depending on whether the underlying asset is property? Why or why not? If not, what alternative approach would you propose and why? We do not agree with classifying leases into Tyco A and Type B leases depending upon whether they represent a property or non-property lease. We believe the proposal complicates lease accounting as each type of lease would impact the financial statements differently requiring financial statement preparers to track and report these differences, as discussed earlier in Question 2. This complexity will create additional cost that far outweighs any financial reporting benefits. Safer. Smarter. Tyco. 4

5 To remove the complexity, we propose the use of a simplified accounting model for all leases with the exception of short-term leases which would be defined consistent with the draft s policy election. Under our proposed simplified accounting model, the right-of-use asset and lease obligation would be recorded at their fair value (present value of lease payments) on the lease inception date. However, the right-of-asset would be amortized on a straight-line basis over the lease term with the lease obligation accreted over the lease term. Under this model, both the amortization and accretion expense would be reflected within operating income and operating cash flows. We further recommend a requirement to disclose the accretion expense in the rollforward without further complicating the income statement. The simplified approach will result in the right-of-use asset and lease obligation being displayed on the balance sheet with lease payments not allocated between interest and amortization expense. We believe this simplified approach will continue to meet the Boards overall objective and is similar to the current GAAP requirements on asset retirement obligations (ASC ). Question 5: Lease Term Do you agree with the proposals on lease term, including the reassessment of the lease term if there is a change in relevant factors? Why or why not? If not, how do you propose that a lessee and a lessor should determine the lease term and why? Yes, we generally agree with the proposals on lease term to include the effect of any options to extend or terminate the lease when a significant economic incentive to exercise the option exists. The Basis for Conclusions highlights the threshold for significant economic incentive which is similar to the concepts of reasonably assured and reasonably certain, which exist in today s model. We appreciate the Boards consideration of our previous comment to consider raising the threshold from more likely than not in the 2010 exposure draft. We also agree with the reassessment of the lease term when there is a change in relevant factors. However, since such reassessment requires significant judgment and could lead to volatility in the income statement, we suggest the Boards provide clarity on when the lease term should be reassessed. For example, when considering asset-based factors such as significant leasehold improvements, should the lease term be reassessed when the lessee commits to renovate or when the renovation activities begin. The timing of this change would affect balance sheet measurement and can affect expense recognition patterns under the current proposal. Question 6: Variable Lease Payments Do you agree with the proposals on the measurement of variable lease payments, including reassessment if there is a change in an index or a rate used to determine lease payments? Why or why not? If not, how do you propose that a lessee and a lessor should account for variable lease payments and why? We greatly appreciate the Boards improvements in this area from the 2010 exposure draft. We generally agree with the proposal that a variable lease payment includes a contingent payment when it is linked to an index or a rate based on the index or rate at the lease commencement, but excludes a contingent payment when it is usage-based or performance-based as these would be recognized in the period in which the obligation for those payments is incurred. However, we believe there will still be significant complexity related to the treatment of variable lease payments upon the re-assessment of lease payments. Re-assessing lease payments based on a rate or index would require lessees to re-measure their right of use asset and lease Safer. Smarter. Tyco. 5

6 liability, and lessors to re-measure their receivable asset, each time rates and indices change, which may be as often as each reporting period. Additionally, we believe the in-substance fixed payment principle in the revised exposure draft will be difficult to apply and may result in diversity of practice among preparers of financial statements. Therefore, we ask the Boards to provide further guidance in this area. Question 7: Transition Subparagraphs (b) through (h) and (k) through (y) state that a lessee and a lessor would recognize and measure leases at the beginning of the earliest period presented using either a modified retrospective approach or a full retrospective approach. Do you agree with those proposals? Why or why not? If not, what transition requirements do you propose and why? Are there any additional transition issues the Boards should consider? If yes, what are they and why? We greatly appreciate the Boards improvements in this area from the 2010 exposure draft, particularly for introducing the modified retrospective approach to transition. However, we encourage the Boards to be even more flexible regarding the transition by introducing provisions to grandfather into the current guidance lease arrangements that existed prior to the effective date of the new standard. Specifically, we recommend that they at a minimum consider grandfathering leases outstanding at the initial application date but that expire prior to the effectiveness of the new standard. Question 8: Disclosure Paragraphs , through 50-10, and through set out the disclosure requirements for a lessee and a lessor. Those proposals include maturity analyses of undiscounted lease payments, reconciliations of amounts recognized in the statement of financial position, and narrative disclosures about leases (including information about variable lease payments and options). Do you agree with those proposals? Why or why not? If not, what changes do you propose and why? We disagree with the level of qualitative and quantitative disclosures proposed in the revised exposure draft as they will result in increased costs to preparers with no incremental benefits to the users of such financial statements. We believe the extensive disclosure requirements may be confusing to users of financial statements contrary to the overall objective of the project which is to improve financial reporting. We believe our recommended single accounting model for all leases (with the exception of short-term leases), as discussed earlier in Question 4, will simplify the proposed accounting for leases and thus reduce the need for significant disclosures. For example, the reconciliation required for both Type A and Type B in for public entities is very extensive and may result in information that will not be utilized or properly understood by users of the financial statements. Safer. Smarter. Tyco. 6

7 Question 9: Nonpublic Entities (FASB Only) To strive for a reasonable balance between the costs and benefits of information, the FASB decided to provide the following specified reliefs for nonpublic entities: 1) To permit a nonpublic entity to make an accounting policy election to use a risk-free discount rate to measure the lease liability. If an entity elects to use a risk-free discount rate, that fact should be disclosed. 2) To exempt a nonpublic entity from the requirement to provide a reconciliation of the opening and closing balance of the lease liability. Will these specified reliefs for nonpublic entities help reduce the cost of implementing the new lease accounting requirements without unduly sacrificing information necessary for users of their financial statements? If not, what changes do you propose and why? Not applicable to Tyco. Question 10: (FASB Only) Do you agree that it is not necessary to provide different recognition and measurement requirements for related party leases (for example, to require the lease to be accounted for based on the economic substance of the lease rather than the legally enforceable terms and conditions)? If not, what different recognition and measurement requirements do you propose and why? We agree with the Board's conclusion that it is not necessary to provide different recognition and measurement requirement for related parties or additional disclosures beyond those required by Topic 850 for related party leases. We do not believe different recognition and measurement requirements for related parties would be appropriate as doing that would be inconsistent with the goal of the project to improve lease accounting. We do not believe the cost of different recognition and measurement and the additional disclosures beyond those currently required by Topic 850 would provide a commensurate benefit for users of financial statements. Question 11: (FASB Only) Do you agree that it is not necessary to provide additional disclosures (beyond those required by Topic 850) for related party leases? If not, what additional disclosure requirements would you propose and why? We agree with the Board s conclusion that it is not necessary to provide additional disclosures beyond those required by Topic 850 for related party leases. See our response to question 8. Question 12: Consequential Amendments to IAS 40 (IASB Only) Do you agree that a right-of-use asset should be within the scope of IAS 40 if the leased property meets the definition of investment property? If not, what alternative would you propose and why? Not applicable to Tyco. Safer. Smarter. Tyco. 7