FASB Clarifies When Leases Should be Reclassified

The Financial Accounting Standards Board (FASB) has answered questions relating to lease accounting.

The way it stands now, FAS 13 requires that a lease should be recalculated when a change in a key assumption affects the net income. One example would be the timing of cash flows connected with income taxes that are generated by a leveraged lease, CFO.com reported.

The FASB staff last July had proposed that after a leveraged lease is recalculated, the lease should be reclassified if the change in the timing of cash flows altered the characteristics of the lease so much that it no longer qualified for leveraged lease accounting. That would mean the debt would have to be recorded as gross instead of net, and the pattern of income recognition would also have to change.

After hearing comments disagreeing with the proposal, the FASB last week decided that a company would not have to reclassify a lease in those circumstances. The board said that the most current information should be used to update all assumptions when a leveraged lease is recalculated.

"We had valid reasons in the draft for requiring it," board member Leslie Seidman said at the meeting, according to CFO.com. She added, however, that the requirement seemed to be "inconsistent with the general premise of FAS 13 that you do not reconsider the classification unless there is a change in the terms" of the lease agreement.

Retailers, restaurants and other companies have been able to keep lease costs off their books for many years, according to the Wall Street Journal. More than 250 earnings restatements, and a recommendation from the Securities and Exchange Commission, got the FASB talking more energetically about overhauling lease accounting guidelines to prevent more problems.

One of the most high-profile lease accounting problem was the 2004 earnings restatement by CKE Restaurants, which operates Hardee's and Carl's Jr. chains. Analyst's Accounting Observer estimated that 270 companies restated, adjusted or reviewed lease accounting.

The board decided against its initial proposal that interest and penalties incurred should be included in the recalculation. FASB also discussed the recognition threshold for deferred taxes in a leveraged lease–“probable” recognition or “more likely than not.” CFO.com reported that according to FASB, no numerical definition of "probable" exists in the accounting literature, but it has become generally accepted as being between 70 percent and 75 percent. "More likely than not" is generally accepted at 50.1 percent. The board agreed on “more likely than not.”

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