By Ted Blendermann, CPA, CFP
In May 2013, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) (collectively “the Boards”) released revised exposure drafts for the proposal of new lease accounting guidance.
If the 2013 proposal is adopted in final form, the guidance will require balance sheet recognition of many previously unrecognized leased assets and liabilities, as well as significant other changes to current accounting principles generally accepted in the United States (US GAAP).
The most significant change in the new proposals calls for a dual-recognition approach to the recognition, measurement, and presentation of expenses and cash flows derived from leasing arrangements, which is summarized below. Additionally, the proposed guidance requires the lessee to recognize a liability for future lease payments and a right-of-use asset for leases with a term of more than twelve months. Short-term leases, defined as leases with a maximum possible lease term of twelve months or less, including renewal options, may be excluded from the proposed exposure draft, and may continue to be accounted for similar to an operating lease.
Under the dual-recognition approach, the accounting by lessees will depend on whether the lessee will consume a more than insignificant portion of the leased asset. Two types of leases identified are as follows:
- Type A Lease: Most leases of assets other than property, in which a more than insignificant portion of the asset will be consumed (i.e., equipment, aircraft, cars and trucks).A lessee will record the lease as a right-of-use asset and a corresponding lease liability, both initially measured at the present value of the future lease payments. The lessee will then recognize and present the amortization of the right-of-use asset separately from interest expense on the related lease liability.
- Type B Lease: Most leases of property, in which a more than insignificant portion of the asset will not be consumed (i.e., land and/or building or part of a building).A lessee will recognize a right-of-use asset and lease liability at the same amount as with Type A. The lessee will then recognize and present a single lease cost on the income statement consisting of the interest on the lease liability with the amortization of the right-of-use asset on a straight-line basis.
The difference between the Type A and Type B lease is in the presentation of the expenses. For the Type A lease, you report the interest and amortization expenses separately. For the Type B lease, you combine the amounts and report as “lease expense”.
One major effect, under the proposed guidance, will be the increased need for professional judgment surrounding the determination of “more than insignificant”. The Boards have included interpretations, including examples and guidance on implementation of this concept. In the examples, it is evident that the determination shall not be made based on the type of leased asset or industry, but all facts and circumstances surrounding the terms of the lease should be considered in identifying the appropriate accounting.
The Boards have met in January, March, April, May and June 2014 to continue redeliberations of the May 2013 exposure draft. However, the effective and implementation date is still unknown at this time.
Should this accounting guidance get passed, there would be a major change in the reporting of information which would have a great impact on the financial statements of organizations. The change would have a ripple effect throughout various industries. The banking and financing industry, for example, would have to rewrite its debt covenants to take into account these changes. Otherwise there would be many unintended failures of the debt covenants due to the changes. The U.S. Department of Education would have to revise the composite score calculation for these changes as well.
McClintock & Associates is monitoring this and will keep you informed as new information becomes available.
Volume 1, Issue 3