The Financial Accounting Standards Board and the International Accounting Standards Board have published their long-awaited joint proposals for overhauling the accounting standards for lease contracts.

The proposals are one of the main projects included in the boards’ memorandum of understanding for accounting convergence and are likely to have a major impact on the way that airlines, commercial and residential property landlords, and equipment rental companies do business.

The current operating lease accounting model allows off-balance-sheet treatment of significant amounts of assets and liabilities of lessees, which has led to problems in estimating their value. Many investors try to estimate the amounts of the assets and liabilities, but they often need to rely on incomplete footnote disclosures in companies’ financial statements and try to use pro forma rules of thumb to make their estimates.

IASB Chairman Sir David Tweedie has frequently joked that it has always been his ambition to travel on an airplane that was on an airline’s balance sheet.

“This proposal would require that all lease obligations would be recorded on the balance sheet at the present value of the expected lease payment, along with an asset representing the right to use the leased asset,” FASB board member Leslie Seidman told WebCPA.

This is sometimes referred to as the “right-to-use model” -- in other words, an asset on the books that represents the present value of the expected lease payments, along with an obligation to make those payments. The effect is similar to the accounting treatment if a company purchased the asset outright and financed it, but only proportionately since it’s usually not the whole asset for its entire useful life.

“For a lot of lessees, this is the first time these amounts will be on the balance sheet,” said Seidman. “For some who had been doing capital lease accounting, all we’re doing is changing the amounts potentially, but for most lessees you’re putting potentially significant amounts on the balance sheet for the first time. The first time they will be at present value, and subsequently these will be carried at amortized cost.”

Similar leasing arrangements can be accounted for very differently under the current standards if they happen to fall on either side of the existing line between operating and capital leases, she added. “This allows structuring to achieve a desired accounting effect,” she noted. “The proposed standard will [instead] require all leases to be recognized, but only to the extent of the rights and obligations that they convey. If you have a short-term lease, you will have a relatively small amount on the balance sheet, and if you have a long-term lease, you will have a relatively large amount on the balance sheet.”

The new proposed standards also potentially change for lessees the pattern and classification of the income and expenses related to the arrangement, she added. “Today if you have an operating lease, essentially you’re taking rental payments over the term of the lease,” said Seidman. “This proposal would put an asset on the books and amortize it, sort of like a depreciation expense, and then put a liability up and record interest expense related to it. First you’ve changed what you’re calling these P&L items, and then you’re changing the pattern of it because the asset will be amortized ratably and then interest expense will be recognized based on a declining liability amount. The pattern is just different from before, but again it’s intended to simulate the accounting if you were to buy it and finance it.”

In a more complicated arrangement where rentals are contingent on sales or there are renewal options that are exercisable at the company’s discretion, the proposal would require the company to make estimates about what those payments are going to be and how long it expects the lease to be outstanding, Seidman added.

“You may hear some folks talking about how it’s a more complex proposal, and I would submit that it depends on how complex your arrangement is,” she said. “If you have a pretty straightforward lease with fixed terms, then I don’t find the accounting for it particularly complex, except to the extent that you have to put something on the balance sheet and account for it. It’s more complex than not doing that.”

The proposal does include an exception for short-term leases, however. “To the extent that you have an arrangement with a maximum possible lease term of 12 months or less, all you have to do is accrue the outstanding lease payments on any reporting date, and you don’t have to go through the effort to amortize the rate of leased assets or accrue interest expense on the liability,” said Seidman. “That’s intended to be a simplification for people who have really short-term leases.”

FASB has been working closely with the IASB on the proposed standards, although there are some minor differences between the proposals released by the two boards. Some are due to cross-references to variations in other standards, such as the impairment standards used by the two boards.

“We haven’t completely eliminated those kinds of differences, but they are not unique to leasing per se,” said Seidman. However, there are also a couple of differences where the boards voted differently on matters affecting leasing, but Seidman said she considers them to be secondary issues that will probably be resolved later once the boards receive all the comments and finalize the standards during re-deliberations. Both boards are providing a four-month comment period for the leasing proposals, with a common deadline of Dec. 15.

FASB voted 5-0 in support of the proposals, she noted, and on the IASB, there were 11 votes in support, one in opposition, and two abstentions from two new board members.

At least one group expressed its displeasure with the proposed standards. Leaseurope, which represents the European leasing industry, complained that businesses’ views were not taken into account during a consultation period last year when the boards received over 300 comments.

“To date, the boards have simply paid lip service to cost/benefit considerations,” said Mark Venus of BNP Paribas, chairman of Leaseurope’s Accounting Committee, in a statement.  “This is very visible in the draft standard that has just come out. The proposals are more than 100 pages in length and only a handful of paragraphs deal with cost/benefit analysis. Leasing and rental provide vital economic benefits for many businesses, and there is a risk that these could be jeopardized unless the proposals are substantially simplified.”

The boards hope to issue a final standard by June 30, 2011, which is the date that the two boards have set for achieving convergence on most of the major outstanding standards, with the rest of the standards to be finalized by the end of next year.

There is no effective date yet for the proposed standards because several other proposed standards are still out for comment. The boards plan to ask in a separate proposal for constituents to comment on the best way to introduce all of the new standards in terms of the transition and effective dates.

“Usually we look at these things one standard at a time, but because there’s such potential for significant change here, we’re going to ask people to help us think that through for all the standards together,” said Seidman. “We’re hoping to issue that in September or October for comment, and after we get the feedback on that and the individual exposure drafts, we’ll set an effective date for this standard and other standards.”

She added that companies that are interested in doing “field work” to try out the new standards should contact FASB by Sept. 15 to volunteer.

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