Exposure Draft Released by FASB on Lease Accounting; Significant Changes Proposed

By Baker Newman Noyes July 2, 2013

On May 16, 2013, the Financial Accounting Standards Board (FASB) released an Exposure Draft of a proposed Accounting Standards Update (ASU) of Topic 842 relating to lease accounting.  If adopted in its current form, this Exposure Draft will have a significant impact on the presentation of and accounting for leases (and subleases) in financial statements, primarily by recording virtually all leases on the lessee’s balance sheet. This will gross up the assets and liabilities and reduce capital ratios.

The Exposure Draft has emerged out of a joint project with the International Accounting Standards Board (IASB). Comments are requested and should be submitted by September 13, 2013. This Exposure Draft is a revision of the 2010 release on the same topic.  The basis for this change is financial statement users’ assertion that omitting leases from a company’s balance sheet is not a complete representation of leasing transactions. Under current accounting guidance, there are two types of leases: operating leases and capital leases.  An operating lease is not reflected on the balance sheet of a company, while a capital lease is recorded as both an asset and a liability.

The Exposure Draft addresses lease accounting from both the lessee and the lessor perspective, and categorizes leases as either a Type A lease or a Type B lease.  Type A leases are generally leases of assets other than property (examples include equipment, vehicles, aircraft, etc.), and Type B leases are generally property leases (land and/or buildings).  Type A leases under this Exposure Draft would be recorded on the lessee’s balance sheet as a right-of-use asset and a lease liability at the present value of lease payments. The unwinding of the discount on the lease liability would be recorded as interest expense separately from the amortization of the right-of-use asset. A lessor would record a Type A lease by removing the underlying asset from the balance sheet and recording a lease receivable (for the lease payments) and a residual asset (for the value of the asset retained by the lessor).  The unwinding of the discount on both assets would be recognized as interest income over the lease term, and any profit relating to the lease would be recognized at the lease commencement date.

Type B leases on the lessee side would also be recorded as a right-of-use asset and a lease liability at the present value of lease payments.  However, the unwinding of the discount of the lease and the amortization of the right-of-use asset would be recognized as a single lease cost on a straight-line basis.  The lessor of a Type B lease would maintain the underlying asset on its balance sheet and recognize lease income over the lease term on a straight-line basis.

Generally speaking, exemption from this guidance exists only if a lease is 12 months or less (including options to extend).

An effective date for this guidance has not yet been determined, and the FASB will consider the significant impact that this proposal will have on reporting entities when determining the effective date.  It is important to obtain an understanding of these changes to lease accounting and evaluate the impact it will have on your company’s financial statements, debt covenants, and accounting systems.

The Exposure Draft also provides significant guidance regarding defining the lease term, determining an interest rate to use for present value calculations, the lease measurement date, sale-leaseback accounting, and other matters of interest.

Access the full exposure draft here: Exposure Draft- Leases Topic 842

This is an important topic that we will continue to monitor for you and provide updates as developments occur. If you would like to discuss this matter further, please contact your BNN advisor at 1.800.244.7444.