Latest Proposed Changes on Accounting for Leases
For some time now, the Financial Accounting Standards Board (the Board), the globally recognized authoritative body on financial reporting in the U.S., has proposed significant changes to the way we account for leases, whether we are the lessee or lessor.
Exposure Draft on Leases
The Board’s ideas started in the form of a Discussion Paper in 2009 and made their way into an Exposure Draft in 2010. While many Exposure Drafts become issued Accounting Standards Updates after a modest period of public comment and review, the Exposure Draft on leases has been the subject of extensive deliberation and outreach activities (i.e., public roundtable meetings, workshops, preparer questionnaires, investor questionnaires, and joint FASB/IASB working group meetings).
In response to the feedback provided to the Board by public comment and other outreach activities, the Board has made significant modifications to the content of the original Exposure Draft on leases. Because the modifications are so extensive, the Board has decided to release a revised Exposure Draft for public comment, scheduled to be released in the second half of 2012. That said, the Board has reaffirmed that the major proposed change in lease accounting (as described below and presented in the original Exposure Draft) will remain intact; the modifications are found in the details.
Operating Leases and the Balance Sheet
Currently, when we account for leases, we first attempt to decide whether we are paying for the right to use leased assets over a period of time (operating lease), or whether we are effectively financing the acquisition of assets (capital lease). Current accounting rules create a “bright line” distinction between capital and operating leases, and use an all-or-nothing approach to presentation on the balance sheet. Because capital leases are treated as financed asset acquisitions, the components of capital leases (acquired assets and financing obligation) are presented on the balance sheet. But the components of operating leases are not presented on the balance sheet.
The Board feels that the way we currently account for leases fails to adequately provide a clear understanding of the lease arrangements to the users of our financial statements. That led the Board to look at leases from an entirely new perspective. This new perspective recognizes that there is value to a lessee’s contractual right to use leased assets over a period of time, and that the lessee has a contractual obligation to pay for that right. So the Board is proposing that the components of operating leases be presented on the balance sheet—an asset should be recognized that represents the value of the right to use leased assets over a period of time, and a liability should be recognized that represents the obligation to pay for that right.
If the components of operating leases are to be presented on the balance sheet, and the components of capital leases are already presented on the balance sheet, the need to maintain a “bright line” distinction between capital and operating leases diminishes. In fact, there is no reason to maintain any distinction between the two. With very few exceptions, there is no reason why all leases shouldn’t be treated in the same way.
The Lease as an Effective Financing of an Asset Acquisition
Supplied with this perspective, the Board shifted its focus to other meaningful factors when determining whether a lease should ever be considered an effective financing of an asset acquisition as opposed to an arrangement to secure the right to use leased assets over a period of time. The Board determined that a lease should be considered an effective financing of an asset acquisition in the very limited circumstances where control of the entire leased asset (together with its accompanying risks and benefits) is transferred to the lessee at the end of the lease term.
The Board has tentatively decided that the components of leases with terms not extending beyond 12 months from commencement (including any options to renew) need not be presented on the balance sheet. And this lease guidance would not apply to leases of intangible assets, leases to explore or use non-regenerative resources (extractive activities), or leases of biological assets.