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Current State of Lease Accounting Standards

Current State of Lease Accounting Standards

For several years now, the accounting standard-setting body in the United States, the Financial Accounting Standards Board (FASB), and the international accounting standard-setting body, the International Accounting Standards Board (IASB), have been working on various convergence projects in an effort to achieve more uniform accounting standards worldwide.
Among the topics in this initiative is lease accounting. It is among the most highly commented-upon topics in the overall project. Several exposure drafts have been issued and revisions continue to emerge. The following is a summary of the major issues agreed upon to date between the governing bodies.

Lessee Accounting Models

All leases will be accounted for by recognizing a right of use (ROU) asset and a corresponding lease liability at lease inception. On this point, FASB and IASB agree. They do not agree on the subsequent recognition. Under FASB’s proposal, lessees will be required to classify leases as Type A or Type B. These classifications are not much different than the existing capital/operating lease classifications, with capital leases becoming Type A leases. Under a Type A lease, lessees would recognize amortization of the ROU asset separately from the interest expense on the lease liability. Under a Type B lease, lessors would recognize a single lease expense. The IASB plans to only use the Type A lease designation.

Lessor Accounting Models

Lessors will also classify leases as Type A or Type B under the same basic principles as lessees, except that the new standard aims to clarify the Type A classification. Specifically, a lessor must assess whether the lease transfers substantially all the risks and rewards incidental to ownership of the underlying asset. If it does not, the lessor may not recognize any selling profit or revenue at lease inception. This concept is meant to be consistent with the recently issued revenue recognition standards. In essence, lessors will continue to account for leases as they are now, whether Type A or Type B.

Lease Terms and Short-term Leases

In evaluating lease terms, lessees and lessors must assess the likelihood of options to extend being exercised. Extension options should only be included if it is “reasonably certain” that they will be exercised. Leases for terms of 12 months or less will be excluded from the new standard and can be expensed currently.

Other Matters

  • Leases between related parties should be accounted for under the terms and conditions of the lease, but the parties must also apply the related party disclosure rules.
  • Generally speaking, the lessor in a sublease (lessee in the original lease) should account for each lease independently of the other.
  • In evaluating a potential sale-leaseback transaction, the new revenue recognition standard must be applied to determine whether a sale took place. The existence of the leaseback does not negate the possibility that a sale has occurred.

For all that has been accomplished to date, the final lease accounting standard does not appear imminent. Early in 2014, the FASB chair stated that he didn’t expect the final standard to be issued until late 2015. Change is certainly coming, we just don’t know when. Until then, all provisions of the new standard remain subject to change.

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