The Financial Accounting Standards Board (FASB) voted 6 to 1 on Nov. 11 to move forward with new accounting guidance that will require companies to include lease obligations on their balance sheets.
Under current accounting standards, a majority of leases are not reported on a lessee's balance sheet. Now, experts say, trillions of dollars in historically off-balance-sheet leases will have to be brought onto companies' books.
âThe changes to the leasing standard are a big deal,â said Anne-Lise Vivier, CPA, accounting publications managing editor with Thomson Reuters Checkpoint within the Tax & Accounting business of Thomson Reuters. âAt a very high level, the upcoming standard will achieve a number of the goals the FASB had set for this project. In particular, most leases will now have to be on the lessee's balance sheet, which is a huge change from current practice. Lessees will, in most cases, have to record a large asset and a large liability on their balance sheet.â
These changes will likely require companies to update their lease systems and processes and related internal controls, according to a PwC brief on the new guidance.
âLessees should focus on their ability to gather the required information on existing leases and capture data on new leases, which will be critical to an effective transition,â the PwC brief says. âIn some cases, new systems, controls, and processes may be warranted, which will take additional time to obtain or develop, implement, and test.â
The new leases standard, which is expected to be finalized in early 2016, is intended to increase transparency and comparability among organizations that lease assets, by recognizing the assets and liabilities that arise from lease transactions, FASB Chairman Russell Golden said earlier this month at a conference in Geneva, Switzerland.
âThe FASB lessee accounting model continues, like today, to account for two types of leases,â Golden said to the Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting on Nov. 4. âOne type of lease â the capital lease â will be accounted for in substantially the same manner as capital leases are accounted for under existing GAAP. The other type of lease â the operating lease â will be accounted for in a manner similar to operating leases under existing GAAP, except that lessees will recognize a lease liability and a lease asset for all of those leases.â
These changes to the income statement are not expected to be as dramatic as what the exposure drafts on the standard had suggested, Vivier said.
âThe FASB is now proposing a dual-model for the income statement that, while not entirely similar to the current model, is a lot closer to it than the model that was discussed in an earlier exposure draft,â she said. âThe FASB has not yet released the standard, or even a draft thereof, so there may be other provisions that will require attention.â
Under the dual-model approach, a lessee would account for most existing capital leases as Type A leases and most existing operating leases as Type B leases.
For types A and B leases, a lessee would recognize a right-of-use asset and a lease liability, initially measured at the present value of lease payments. For Type A leases, the lessee would also recognize and present the interest on the lease liability separately from the amortization of the right-of-use asset. For Type B leases, the lessee would also recognize a single lease cost, combining the interest on the lease liability with the amortization of the right-of-use asset, on a straight-line basis.
âWe believe that this new standard is important because it will provide investors, lenders, and other users of financial statements a more accurate picture of the long-term financial obligations of the companies to which they provide capital,â Golden said in a written statement following the board's vote on Wednesday.
Public companies will be required to adopt the new leasing standard for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2018. For calendar year-end public companies, this means an adoption date of Jan. 1, 2019, and retroactive application to previously issued annual and interim financial statements for 2018 and 2017.
Nonpublic companies will be required to apply the new leasing standard for fiscal years beginning after Dec. 15, 2019, and interim periods within fiscal years beginning after Dec. 15, 2020. For nonpublic calendar year-end companies, this means an adoption date of Jan. 1, 2020, and retroactive application to previously issued annual financial statements for 2019 and 2018.
The FASB decided to allow early adoption of the new leasing standard once it is issued.
As a next step, the FASB staff will complete a âballot draftâ of the Accounting Standards Update that includes all of the board's final decisions. The ballot draft will be shared with each of the seven board members, who will review it to ensure that it accurately reflects decisions made throughout their public deliberations. The draft will be submitted for final publication once board members are satisfied that it reflects their intentions.
âWith the expected issuance of the standard in early 2016, companies will have only three years before they begin reporting under the new guidance,â the PwC brief says. âCompanies that have not done so already will want to think through the potential impact, particularly in light of the requirement to retroactively apply the standard to previously issued financial statements. The timeline for adoption will be even shorter to the extent a company plans to early adopt the standard. With uncertainty as to the effective date now resolved, preparers can now begin to develop a plan for an orderly and smooth transition.â