At long last, the Financial Accounting Standards Board and the International Accounting Standards Board have published their second draft of a proposed standard to overhaul lease accounting in a way that would bring all but the shortest-term leases on to corporate balance sheets. Three of FASB's seven members are not on board with the proposal, however, calling it overly complex, overly burdensome on preparers, and missing the mark in providing information that will be useful to investors. Two IASB members also dissented, and all of their alternative views are included with the proposal.
FASB and the IASB built the proposed new standard around a core principles that assets and liabilities arising from a lease should be recognized on the balance sheet, a concept unchanged from the boards' original proposal in September 2010. The new standard would require any lease of more than 12 months to be reflected in balance sheets with a liability to reflect the obligation to make lease payments and an asset representing the company's right to use the leased asset for the term of the lease. "Even though this is the second draft, we have retained the same basic principle," says FASB Chairman Leslie Seidman. "Leases convey valuable rights and obligations that belong on the balance sheet."
Currently, leases structured as “capital leases” are treated like the financed purchase of an asset and booked accordingly, while “operating leases” are treated more like rental agreements with the lease payment recognized as an ordinary expense over the life of the lease. FASB and IASB initially sought to end such distinction by having all leases treated like asset purchases, but through feedback and outreach determined they needed to make a provision for economic differences among leases. As a result, the boards came up with an approach that would lead to different ways of recognizing, measuring, and presenting expenses and cash flows associated with leases depending on whether an entity expects to consume “more than a insignificant portion” of the economic benefits associated with the leased asset.
For leases of assets other than property, such as equipment, a company would recognize a “right-of-use” asset and a lease liability measured at the outset based on the present value of the lease payments, then recognize and present the interest on the lease liability separately from the amortization of the asset. For property leases, such as land or buildings, the proposed standard would require companies to recognize a right-of-use asset in the same way, but recognize a single lease cost on a straight-line basis, combining interest and amortization. The proposal also includes disclosure requirements that are meant to help users of financial statements understand the amount, timing, and uncertainty associated with lease-driven cash flows.
“Because of the prevalence of leasing, it is important for users of financial statements to have a complete and understandable picture of an organization's leasing activity,” said FASB member Russ Golden in a brief FASB video to explain the proposal. The proposal is meant to address the criticisms heard over the years from users of financial statements that current lease accounting rules do not produce information that reflects the true economics of lease transactions. “Most users we have spoke to adjust the reported financial information to reflect assets and liabilities arising from leases,” he said.
Golden is due to take over the chairman's position on July 1 when Leslie Seidman's term on the board expires. As the board cast its final votes for issuing the proposal despite misgivings over complexity, Golden backed the proposal believing it was an improvement over existing accounting rules. “We are getting rid of the concept where minor changes in the economics will have drastic difference in the balance sheet,” he said then. Board members Tom Linsmeier, Hal Schroeder, and Marc Siegel have offered their alternative views say the board's proposal is too complicated and will be too costly for preparers to follow. They also worry it will still fall short in providing users with information that fully reflects the economics of leasing.
The proposal is open for comment through Sept. 13. FASB says it will conduct roundtables and field tests before finalizing the proposal. The boards have not set a final effective date, waiting instead to see what will be in store for them as a result of feedback on the proposal. IASB Chairman Hans Hoogervorst said he is hopeful the boards will finalize the standard in the first half of 2014.