Lease Accounting Overhaul

Lease Accounting Overhaul

Leases are an essential tool for many organizations, allowing them to gain access to property and equipment, while mitigating exposure to risks of asset ownership and reducing initial cash outflows with payments made over a set term. Whether they are a public or private company, or non-profit organization, an entity can lease a variety of assets for use such as vehicles, buildings, and construction and manufacturing equipment. The practical application of accounting for leases can be challenging, with highly tailored lease arrangements presenting additional challenges. Current guidance for lease accounting requires companies to classify leases as capital leases (on-balance sheet) or operating leases (off-balance sheet). Under these rules, future payment obligations for capital leases are recognized as debt liabilities, while payments due under operating leases are not reflected on the balance sheet. As leasing has become more prevalent, so has the support for financial statement presentation and disclosure that better reflects the economics of lease arrangements and provide increased transparency to users of the financial statements. The ongoing debate has centered on how to achieve greater transparency. Financial statement users are pushing for rules that would require lessees to recognize these assets and liabilities on their balance sheets.

The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) issued revised joint proposals on leases in May 2013: the IASB’s Exposure Draft, Leases, and the FASB’s Proposed Accounting Standards Update, Leases (Topic 842) (a revision of the 2010 Proposed Accounting Standards Update, Leases (Topic 840)). The proposed revised standards could bring changes for many types of businesses, as the standards would require that all leases with a maximum possible term of more than 12 months be recognized on the balance sheet as both an asset and a liability, similar to the current treatment of capital leases. For most leases of assets other than property, a lessee would recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing the lessee’s right to use the leased asset (the underlying asset) for the lease term. A lessee would recognize the unwinding of the discount on the lease liability as interest separately from the amortization of the right-of-use asset. Also included in the revised proposals were the creation of two methods for profit and loss statement recognition, which could potentially impact the income statement presentation for both lessees and lessors. These changes would affect the recognition, measurement, and presentation of expenses and cash flows arising from a lease, impacting many key financial metrics.

Although the revised standards have not been finalized to date, and further deliberations are expected, organizations can begin to prepare now for the upcoming changes and the effect on their financial statements and key financial metrics. Debt-laden balance sheets could lead organizations to re-negotiate current lease agreements, revise their current lease-buy decision analysis, and even limit an organization’s ability to acquire new debt. Organizations can expect the revised accounting standards to have significant impacts on business processes, systems, and controls, while also increasing regulatory compliance requirements. Organizations can begin to prepare their systems and processes now to support the data capture required by the proposed changes.

For questions about how these upcoming changes may affect your business, please contact Barbara Walker, CPA, MBA, Partner, at barbw@mksh.com.


Article provided by: Jessica Sipple, Staff Accountant

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