May 20, 2013
Lease Accounting Changes Would Have Widespread Effects
On May 16, 2013, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued for comment the long-awaited revision of the proposed Accounting Standards Update (ASU) that, if adopted, would result in major changes to lease accounting. The proposal, “Leases (Topic 842): A Revision of the 2010 Proposed FASB Accounting Standards Update, ‘Leases (Topic 840),’” would change the standards for lease accounting for both lessees and lessors. The jointly developed revised exposure draft is a significant step forward for the boards’ efforts to converge the lease accounting rules of U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).
If the revised exposure draft is adopted, the change in lease accounting rules would affect nearly every entity that engages in lease contracts.
For lessees, this proposal would almost completely eliminate an entity’s ability to have off-balance-sheet leases and instead require most leases to be recognized as an asset and liability on the balance sheet. Lessees could see significant changes to both U.S. GAAP financial metrics (such as interest expense and the timing of recognition of lease expenses in net income) and non-GAAP metrics (such as working capital ratios and earnings before interest, income taxes, depreciation, and amortization). If the new standard is adopted, some changes could affect contractual agreements such as debt covenants and contingent consideration arrangements, and entities might be required to add internal controls or make changes in their IT systems.
For lessees, significant aspects of the exposure draft include the following:
- It defines the lease term as the non-cancelable period that the lessee has the right to use the asset, including any option periods in which the lessee has a significant economic incentive to maintain the lease.
- Lessees would recognize all lease contracts with a lease term of more than 12 months as assets (“right-of-use” assets) and liabilities (“lease liabilities”).
- It permits an accounting policy election for lessees to recognize payments on leases with a lease term of 12 months or less that do not contain a purchase option in profit or loss on a straight-line basis over the lease term.
- Most leases of assets other than property (which the proposal labels Type A leases) would recognize interest expense (effective interest method) and amortization expense.
- Most leases of property (which the proposal labels Type B leases) would recognize a single lease cost on a straight-line basis over the life of the lease.
- Lessees would exclude most variable lease payments from the measurement of assets and liabilities.
Similarly for lessors, the rules significantly change the criteria for recognizing lease assets, which may affect the timing and nature of revenues and expenses for lessors. Following are some of the significant aspects of the exposure draft for lessors:
- For each lease contract, lessors would be required to use one of two accounting models, referred to as Type A and Type B, which will use the same criteria as the models for lessees. (Most property leases would be considered Type B leases, and other-than-property leases would be considered Type A.)
- Type A leases would be treated similarly to the existing guidance for sales-type leases; that is, the underlying asset would be derecognized at the inception of the lease, and the lessor would recognize a lease receivable, a residual asset, and any resulting profit or loss.
- Type B leases would be treated similarly to operating leases for lessors; that is, the lessor would retain the underlying asset and recognize lease payments into income or loss over the lease term on a straight-line or other systematic basis.
The revised proposal takes into account comment letters and other feedback the FASB and IASB have received about their original proposals. The exposure draft does not include a proposed effective date.
Comments on the new exposure draft are due Sept. 13, 2013.
For More Information
Sydney K. Garmong
Glenn E. Richards
Alex J. Wodka
Partner, General Audit Services