The Financial Accounting Standards Board and the International Accounting Standards Board have taken their first major step toward overhauling lease accounting with a
discussion paper outlining their plans.
As expected, the approach would eliminate the distinction between “operating” leases and “capital” leases, bringing more assets and liabilities related to lease agreements onto the balance sheet, said Bruce Pounder, president of accounting education firm Leveraged Logic. “Essentially, they’re getting rid of the operating lease, so you wouldn’t have a distinction between an operating lease and a capital lease,” he said. “Therefore you wouldn’t have different treatment.”
Under current Generally Accepted Accounting Principles, operating lease payments are treated as regular expenses through the income statement, and result in no asset or liability hitting the balance sheet. Capital leases, on the other hand, are treated more like the acquisition of an asset, giving rise to an asset and a liability. The current distinction between a capital lease and an operating lease is a bright line in accounting rules, leading many entities to structure lease agreements in ways that produce the desired accounting result.
FASB and IASB said leasing experts estimate annual leasing volume in 2007 at $760 billion, yet many of those lease obligations are not reflected on balance sheets. The accounting boards say users of financial statements have called for a single accounting treatment for all leases to eliminate different treatment that produces incomparable financial statements.
The boards propose that all lease agreements should result in the recording of an asset, which is the right to use the leased property, and a liability, which is the future rent payments to be made over the life of the lease. The preliminary discussion paper addresses a number of other issues with respect to accounting for leases, including how to treat options to renew, purchase options, contingent rental arrangements, and residual value guarantees, among others. The boards also noted there are a number of issues still to be explored before a standard can be proposed.
The boards are open to comment on the preliminary views discussion paper through July 17.