Lease Accounting Rules Continues to Evolve

Lease Accounting Rules Continues to Evolve

The lease accounting train continues to chug along towards its final destination and is due to arrive this December. Originally scheduled for finalization this June, there were some surprise detours along the way. Preparers and users of financial statements spoke loudly and the rule makers listened!

Changes to Lease Accounting

However, unless another detour is taken, virtually all leases will be recognized on the balance sheet. An asset will recognize the right to use the property, and a liability will recognize the obligation. Despite the original goal of a single model for the accounting for leases, that will not happen. For example, leases extending for periods shorter than a year and other transactions that would have been considered leases under the Exposure Draft will use existing operating lease accounting rules. As a result, the balance sheet and income statement treatments from lease activities will continue to be different depending on the type of lease.

Another significant change intended to reduce what many believed to be unnecessary complexity under the proposal addresses the handling of lease extensions. The FASB and IASB (the Boards) have settled on a higher threshold for including lease extension options in the calculation of lease term. This will result in shorter lease terms and, as a result, smaller amounts recognized on the balance sheet. Instead of using the “more likely than not” test, the revised thinking would include only those extension options where there is a significant economic incentive to exercise. Some work on the necessity of recurring assessments with guidance on market factors and considerations is expected.

A derailment on lessor accounting has occurred. The Boards heard the conductors and passengers loud and clear. Back off! Apparently, the FASB is now willing to follow IAS standards for lessor accounting (IAS17), which will change existing practice in some industries and eliminate entirely leverage lease accounting under US GAAP. This is a huge blow to establishing a single model for lease accounting.

The tentative conclusions reached on sale/leaseback accounting are consistent with US GAAP except the proposal would now include equipment.

There are numerous issues yet to be resolved, such as sublease accounting, the handling of lease modifications and terminations, financial statement disclosures, impairment, interaction with asset retirement measurements and obligations, and transition. At this point, the earliest a new standard would be effective would not likely be before 2014. Stay tuned.

As noted above, the new rules will have a significant impact on virtually every entity. Despite the attempt to reduce their complexity, the new rules will be complex. They will likely result in entities having to renegotiate debt covenants (since liabilities will go up), and new systems will have to be implemented to keep up with the bookkeeping. If your company has a lot of leases, we urge you to contact us to discuss the possible impacts.