Businesses await new standard for lease accounting

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are on track to publish the final version of a common standard on lease accounting during the second quarter of 2011. The standard could go into effect as early as 2013.

With leasing such a common business activity, companies and their accountants and business advisers must now begin to examine the implications of the new standard, which will require all leases be accounted for on the statement of financial position as capital leases. It eliminates the separate treatment for operating leases, which have been carried off the balance sheet as rent expense. Companies with numerous operating leases should begin the transition to capital leases and also should consider how certain features of leasing under the new standard might be more advantageous to their businesses.
One company that already has incorporated the new lease accounting rules into its business planning is global security company Northrop Grumman Corp., which is moving its headquarters from Los Angeles to Virginia. Northrop Grumman recently announced that it would purchase an older office building in Falls Church, Virginia, rather than enter into a lease arrangement in a newer building, as the company had done for 20 years in California.
While Northrop Grumman also took into consideration the low cost of borrowing money, it concluded that the proposed accounting standard would make it less advantageous to lease real estate, a company spokesperson said.
"Buying made sense, anyway; it just made more sense in light of the rules," said Gaston Kent, a vice president of finance with Northrop Grumman, according to The Wall Street Journal.
Owners of rental property might need to retool some of their business arrangements, not just their lease terms. At a recent real estate roundtable, some companies expressed concern that the new standard might create pressure to sign shorter leases, according to The Wall Street Journal. Building owners could then face the loss of long-term leases that are central to their current financing strategies.
At their most recent videoconference held in July, FASB and IASB turned to the issues that would need to be resolved in developing the new standard for lessors. They had considered lessee accounting in detail in their 2009 Preview Discussion paper.
Lessor accounting
Tentative decisions reached at the July meeting focused on application guidance on when to use the performance obligation or derecognition approach to lessor accounting.
With respect to lessor risk, the boards said, “A lessor that retains exposure to significant risks or benefits associated with the underlying asset should apply the performance obligation approach to such leases. A lessor that does not retain exposure to significant risks or benefits associated with the underlying asset should apply the derecognition approach to such leases.”
Lessee accounting
In their Preview Discussion paper, Snapshot: Leases – Preliminary Views, the boards said that they decided that the scope of the new standard would exclude:
  1. Leases of intangible assets
  2. Leases to explore for or use natural resources, such as minerals, oil, and natural gas
  3. Leases of biological assets
  4. Contracts that represent the purchase (lessee) or sale (lessor) of the underlying asset. A contract is a purchase or a sale if at the end of the contract, the contract transfers:
    1. Control of the underlying asset
    2. All but a trivial amount of the risks and benefits associated with the underlying asset
They also had reached tentative decisions in the following areas of accounting for leases among others:
  • Timing of initial recognition
  • Business combinations
  • Sale and leaseback transactions
  • Arrangements containing both service components and lease components
  • Accounting for subleases
  • Contingent rentals and residual value guarantees
FASB and IASB initiated the project to reconsider lease accounting in 2006. At the time, FASB member Leslie F. Seidman said that "the board has been asked to take a fresh look at the current accounting standards on leasing for a few reasons. First, investors are concerned that existing standards do not require balance sheet recognition of significant assets and liabilities arising from leases. Second, current accounting guidance in this area is rules-based and voluminous.”
In 2009, in their Preliminary Discussion paper, the boards said they decided that the underlying principle for lease accounting would be that lease contracts create assets and liabilities that should be recognized in the financial statements of lessees.
They also said that they had undertaken the project because:
  • Users complain that financial statements do not clearly depict the effects of operating leases.
  • Similar transactions can be accounted for very differently.
  • The standards provide opportunities to structure transactions so as to achieve a particular lease classification.
The new standard will replace FAS 13, Accounting for Leases, which has been amended several times since it was published in 1976.

Frequently Asked Questions: FASB-IASB Exposure Drafts on Leases

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