However, Devil May Be in the Details On Precisely How Companies will Account for Expenses Under Proposed Rules
International accounting rule makers have set aside months of differences over how companies should account for lease expenses on their balance sheets, opting for two methods rather than a single unified approach that would guide both property and equipment lease transactions.
While the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have agreed that companies should be required to capitalize leases on their balance sheets as assets and liabilities as part of an overhaul of lease accounting rules, they had not been able to reach a consensus on a pattern for how lessees should record expenses under various types of leases, including property leases and equipment leases.
The boards cleared a major roadblock on that front last week, agreeing on an approach for lease expenses that would treat some leases as amortized "right of use" straight-line expenses and others in which lease expenses would be allocated evenly over the duration of the lease.
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While the decisions reached at the joint meeting of the boards in London on June 13 are preliminary, they clear the way for FASB/IASB to release a new joint exposure draft in the fourth quarter of 2012, with a final version coming out in the middle of next year and implementation starting in 2016.
If only it were so clear cut. Despite the apparent breakthrough, details of the new classifications may set up further conflicts between the interests of holders of property and equipment leases, said Mindy Berman, managing director of capital markets for Jones Lang LaSalle, one of the firm's resident experts on the lease accounting issue.
"The positive is that the board understands that there are many types of leases and motivations for leasing, and it’s not just a form of financing," Berman said. "That’s the big breakthrough we’ve been working on for more than a year."
However, Berman's skeptical side suspects that the board decision and the details on where the exact dividing line exists between lease classifications are far from clear, Berman said. Specifically, the agreement sets up a polarization between holders of real estate and equipment leases.
"I would caution the real estate community that while this is a victory on the surface, this polarization is not constructive," she said, adding that real estate stakeholders "should not be lulled into complacency."
"There’s a danger that the boards, users or others will realize there are more questions than answers," Berman said.
The boards undertook the issue as part of a project to revise lease accounting in International Financial Reporting Standards (IFRSs) and the U.S. Generally Accepted Accounting Principles (U.S. GAAP). The boards sought to address the widespread concern that many lease obligations currently are not recorded on the balance sheet and that the current accounting for lease transactions does not reflect the economics of all lease transactions.
FASB and IASB have continued to discuss the classifications and pattern of expenses in the income statement. In the decision reached last week, the boards decided upon an approach in which some lease contracts would be accounted for using an approach similar to that proposed in the previous 2010 exposure draft, while other would be accounted for using an approach that results in a straight-line lease expense.
"The boards have reached agreement on a proposed approach to put leases over one year on the balance sheet," said Hans Hoogervorst, chairman of the IASB. "We will publish our proposals for public comment, with a view to completing this important convergence project during 2013."
"The boards carefully considered the diverse views of stakeholders about whether the income statement profile of all leases should be the same," said FASB Chairman Leslie F. Seidman. "On balance, we decided that leases that convey a relatively small percentage of the life or value of the leased asset should be recognized evenly over the lease term."
The boards tentatively decided that a lessee should distinguish between those different leases based on whether the lessee acquires and consumes "more than an insignificant portion of the underlying asset" over the lease term.
The principle should be applied by using a practical expedient based on the nature of the underlying asset. Leases of property, including land or a building, part of a building, or both, should be accounted for using the straight-line approach unless lease term is for the major part of the economic life of the asset; or the present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset.
Leases of assets other than property such as equipment should be accounted for using an approach similar to that proposed in the 2010 exposure draft unless the lease term is an insignificant portion of the economic life of the asset; or the present value of the fixed lease payments is insignificant relative to the fair value of the underlying asset.
For lessors, the boards tentatively decided to change the earlier decisions on the lessor accounting model that is used to determine when the receivable and residual approach would apply.
FASB and IASB decided that a lessor should distinguish between leases to which the receivable and residual approach applies, and leases to which an approach similar to operating lease accounting applies using the same criteria for lessee accounting. Thus, a lessor would apply the receivable and residual approach to leases for which the lessee acquires and consumes more than an insignificant portion of the underlying asset over the lease term.