Much-awaited leases proposal includes dual-recognition approach

One of the most challenging international convergence projects attempted by FASB and the International Accounting Standards Board (IASB) cleared an important hurdle Thursday with the proposal of a revised financial reporting standard for leases.

FASB and the IASB released nearly identical, revised exposure drafts that call for a dual-recognition approach to the recognition, measurement, and presentation of expenses and cash flows arising from leases. Lessees would recognize assets and liabilities for leases of more than 12 months.

The proposals are available at the boards’ respective websites, fasb.org and ifrs.org. Comments are sought by Sept. 13.

The leasing project has been challenging, partly because the varied nature of leases has made it difficult to develop one approach to financial reporting that applies to all of them.

Although investors wanted a single approach to lease accounting, there were differing opinions regarding what that approach should be, FASB Chairman Leslie Seidman said recently. The boards first proposed a leasing standard in August 2010, but changed their approach after getting feedback from stakeholders.

The dual-recognition approach was the main difference between the original proposal and the proposal released Thursday. The current proposal calls for:

• Lessees to report a straight-line lease expense in their income statement for leases where a lessee pays for only the use of the asset and does not consume a more than insignificant portion of the asset. This would include most real estate leases.
• Lessees to report amortization of assets separately from interest on the lease liability for leases during which consumption of a more than insignificant portion of the asset occurs. This type of lease would be recognized as a nonfinancial asset measured at cost, less amortization. This would result in a total lease expense that generally would decrease over the lease term. This approach would be used for most equipment and vehicle leases.
• Equipment and vehicle lessors to account for leases that are off balance sheet in ways that would provide more transparency about the lessors’ exposure to credit risk and asset risk.

The dual approach requires judgment in some cases on the issue of what is considered “more than insignificant.” To aid with interpretation of that concept, the boards included examples and implementation guidance in their EDs. Some cases—such as a 30-year lease on a commercial property with an economic life of 40 years—might require consideration of a broad set of circumstances to determine which approach to use.

The dual-recognition approach may disappoint some investors who were hoping for a one-size-fits-all treatment. And the proposal received only a narrow, 4–3 approval from FASB, partly because of concerns that it introduces complexity for users by revealing lease information in multiple places in the financial statements without bringing it all together in one footnote.

But Seidman said in a news release that the proposal is responsive to the widespread view of investors that leases are liabilities that belong on the balance sheet. IASB Chairman Hans Hoogervorst said in a news release that the proposal will go a long way toward improving the quality and comparability of financial reporting for leases.

Arriving at a converged standard could result in a significant rise in global comparability because of the number of organizations that use leases.

“At present, investors must take an educated guess to determine the hidden leverage from leasing by using basic disclosures in financial statements and applying arbitrary multiples,” Hoogervorst said. “It is clearly not in the best interests of investors to expect analysts and others to guess the liabilities associated with leases.”

—Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.