For lessees, 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 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. Leases of real property typically qualify as operating, or Type B, leases. Therefore, balance sheets for professional service firms will begin to reflect right-of-use assets and corresponding lease liabilities. The lease liability will generally be calculated as the present value of the minimum lease payments. Income statements will continue to reflect a single line for rent expense for office space, but will split the cost of equipment rental (often classified as capital leases, hence a Type A lease) between rent and interest.
In evaluating lease terms, lessees 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.
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.
It is important to note that these rules only apply to GAAP basis financial statements. Entities that report on an income tax basis will not be affected by these rules.
For all that has been accomplished to date, the final lease accounting standard does not appear imminent. Earlier this year, 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.