Leasing

WHY DO WE NEED A NEW STANDARD ON LEASING?

The FASB undertook the leases project to address the widespread criticism that the current accounting for lease transactions (most are off-balance sheet) does not represent the economics of all leases.

Leasing is an important activity for many organizations—whether a public or private company, or a not-for-profit organization. It is a means of gaining access to assets, obtaining financing, and reducing an organization’s exposure to the risks of asset ownership. Many organizations lease assets such as real estate, airplanes, trucks, ships, and construction and manufacturing equipment. 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 activities.

The SEC staff in 2005 identified leasing as a form of off-balance sheet accounting that needed to be addressed. The FASB and the International Accounting Standards Board (IASB) have since been working together to improve and converge the accounting for lease rights and obligations.

On May 16, 2013, the FASB and the IASB issued Proposed Accounting Standards Update, Leases (Topic 842)—A revision of the 2010 Proposed FASB Accounting Standards Update, Leases (Topic 840), which proposed a new approach to lease accounting that would require assets and liabilities arising from leases to be recognized on the balance sheet.
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HOW WOULD THE NEW STANDARD CHANGE CURRENT U.S. GAAP?

Under current U.S. Generally Accepted Accounting Principles (U.S. GAAP), an organization applies a classification test to determine the accounting for the lease arrangement. For example:
  • Some leases are classified as capital leases (for example, a lease of equipment for nearly all of its life) whereby the lessee would recognize lease assets and liabilities on the balance sheet.
  • Other leases are classified as operating leases (for example, a lease of new office space for 10 years) whereby the lessee would not recognize lease assets or liabilities on the balance sheet.
When assets and liabilities for leases are not recognized on the balance sheet, most users of financial statements make adjustments to the financial statements (using disclosures and other available information) to estimate the effects of leases on a lessee’s financial statements.

The new standards would increase transparency and comparability among organizations that lease assets, by recognizing assets and liabilities that arise from lease transactions.
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CORE PRINCIPLES

The core principle of the project is that an organization that is a lessee should recognize assets and liabilities arising from a lease for leases with a lease term of more than 12 months. This represents an improvement over existing leases standards, which do not require lease assets and lease liabilities to be recognized by many lessees.

An organization would provide disclosures to enable users of financial statements to understand the amount, timing, and uncertainty of cash flows arising from leases.

The FASB tentatively decided to amend the lessee and lessor accounting proposals in the 2013 proposed Accounting Standards Update, while retaining the core requirement that lessees should recognize lease assets and liabilities for leases with a term of more than 12 months.

Lessees


The FASB tentatively decided on a dual approach for lessee accounting, with lease classification determined in accordance with the principle in existing lease requirements (that is, determining whether a lease is effectively an installment purchase by the lessee).Under this approach, a lessee would account for most existing capital leases as Type A leases and most existing operating leases as Type B leases.
  • For Type A leases (i.e., effectively an installment purchase), a lessee would do the following (consistent with existing capital lease accounting):
    • Recognize a right-of-use asset and a lease liability, initially measured at the present value of lease payments
    • Recognize and present the interest on the lease liability separately from the amortization of the right-of-use asset.
  • For Type B leases, a lessee would do the following:
    • Recognize a right-of-use asset and a lease liability, initially measured at the present value of lease payments
    • Recognize a single lease cost, combining the interest on the lease liability with the amortization of the right-of-use asset, on a straight-line basis.

The IASB tentatively decided that all leases should be accounted for by lessees as Type A leases, in the manner described above (i.e., effectively every lease would be reflected as an installment purchase).

Lessors

The Boards decided to retain most aspects of existing lessor accounting in the final leases standard. Lessors would classify leases as Type A or Type B in a manner consistent with current U.S. GAAP and IFRS. Most existing sales-type or direct-financing leases would be Type A leases, while most existing operating leases would be Type B leases

Type A leases would be accounted for in a manner substantially similar to that for current sales-type/direct-financing leases (and for IFRS, finance leases), while Type B leases would be accounted for in substantially the same manner as current operating leases.

In addition, the FASB decided that manufacturer/dealer profit on Type A leases should only be recognized at lease commencement if the lease transfers control of the underlying asset to the lessee, consistent with the definition of a sale in the Boards’ forthcoming revenue recognition standard.
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WHAT DOCUMENTS HAVE BEEN ISSUED TO DATE?


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What Are the Next Steps In the Process?

The FASB and the IASB conducted extensive outreach to obtain feedback on the proposed Accounting Standards Update and are currently redeliberating those proposals.


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