Proposal Would Require Most Leases to Appear on the Balance Sheet

August 17, 2010

FASB and the International Accounting Standards Board (IASB) today unveiled a joint proposal to revamp lease accounting.

 

The proposal would result in a single “right-of-use” approach applied consistently to lease accounting for lessees and lessors. Among other changes, the approach would result in the liability for payments under all lease contracts within the scope of the standard and the right to use the underlying asset being included on the lessee’s balance sheet. The standard setters say the changes would improve the information available to investors and other financial statement users about the economics surrounding lease contracts.

The leasing industry plays an important role in many economies by helping companies manage cash flow and working capital,” IASB Chairman Sir David Tweedie said in a press release. “ However, much of the estimated annual $640 billion of lease commitments fails to appear on the balance sheet of lessees, thereby giving a false impression of companies’ liabilities and gearing.”

 

Unlike their discussion paper, Leases: Preliminary Views , pub lished in March 2009, which focused primarily on lessee accounting, the exposure draft, Leases, would result in changes on both sides of a lease transaction. The proposal includes simplified accounting for short-term leases—leases having a maximum term of 12 months or less. The simplified accounting would allow lessees to ignore the effects of interest on the recorded assets and liabilities and allow the lessee to record the liability for lease payments at the undiscounted amount for lease payments.

 

Under current U.S. GAAP and IFRS requirements, financial reporting for lease contracts depends on the classification of a lease. When a contract is classified as an operating lease, the lessee does not record any assets or liabilities on its balance sheet. The current approaches can also allow two similar leases to be accounted for in very different ways if they fall just over the line into operating or capital leases, FASB board member Leslie Seidman said in an interview.

 

“The proposal would remedy both of those criticisms by saying that in all cases the lessee needs to record an asset and a liability for the present value of the expected lease payments,” Seidman said. “And the liability will represent an obligation to make lease payments, and the asset will represent a right to use a leased asset.”

 

Companies using capital lease accounting “will potentially be changing the amount because, if you have a lease that has renewal options, termination options, contingent rentals and other variable lease terms, what we’re asking people to do is estimate the effect of those provisions on how long they think the lease is going to remain outstanding, but there we’re saying what’s the maximum lease term that you think is more likely than not,” to occur, Seidman said.

 

On the lessee side, industries such as retail, airlines, trucking, railroads, businesses with fleets of vehicles and banking are likely to be among the most affected by the proposed accounting changes, she said. Lessor industries such as real estate, equipment manufacturers, information technology, medical equipment and banks are also affected by the proposal. But Seidman doesn’t think the proposed changes would dampen leasing activity. “ It’s hard for me to understand how just a change in accounting would cause people to change their view about the benefits of leasing,” she said.

 

The following would not be covered by the proposal:

 

  • Contracts that are labeled as leases but are actually purchase or sale arrangements.
  • Leases of biological assets.
  • Leases of intangible assets (for example, software, patents and licenses) and leases to explore for or use minerals, oil, natural gas and similar resources.

 

The proposal is open for comment until Dec. 15 and is available via the “Comment on a Proposal” section of ifrs.org or the FASB "Exposure Documents Open for Comment" page on  fasb.org . FASB and the IASB have said June 2011 is their target date for a final standard.

 

The boards have received extensive input on the lease accounting project, including more than 300 comment letters received following the release of the discussion paper (click here to read a comment letter from the AICPA’s FinREC, formerly AcSEC).

 

FASB and the IASB are planning round-table meetings and other outreach efforts during the exposure draft’s four-month comment period.

 

As part of that push for feedback, the boards are asking for volunteers by Sept. 15 willing to take part, on a confidential basis, in fieldwork to discuss and test the provisions, including the costs and benefits of the proposed changes. The fieldwork would be conducted during the exposure draft’s comment period.

 

The IASB will hold an interactive webcast introducing the proposed standard at 10:30 a.m. London time Wednesday and will replay the webcast at 3:30 p.m. London time. To register, click here .  

 

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