The Financial Accounting Standards Board ( FASB ) has released Proposed Accounting Standards Update ( PASU ) (Revised), a revision of the 2010 proposed FASB Accounting Standards Update, Leases (Topic 840). The guidance in this PASU was developed through a joint project with the International Accounting Standards Board ( IASB ), which has also released a similar Exposure Draft. Currently, United States Generally Accepted Accounting Principles require leases to be classified as either capital or operating, based on established criteria. Capital leases require the lessee to book an asset and corresponding liability equal to the net present value of future lease payments associated with the lease agreement. The asset is generally required to be amortized over the shorter of the asset s useful life or the term of the lease, and as payments are made, a portion is allocated to reduce the liability and a portion is recognized as interest expense. If classified as an operating lease, no asset is booked and lease payments are expensed as incurred. The guidance in this PASU affects both lessors and lessees.
Key provisions of the proposed guidance for leases, from a lessee’s perspective, are as follows:
1. For leases with a maximum possible term of more than 12 months, a lessee would be required to recognize an asset and liability. The lessee would recognize a liability to make lease payments and a right-of-use asset representing its right to use the leased asset (the underlying asset) for the lease term. The underlying asset is defined as an asset that is the subject of a lease for which a right to use that asset has been conveyed to a lessee. The underlying asset could be a physically distinct portion of a single asset.
2. The subsequent accounting for the lease will be based on its classification as either a Type A or a Type B lease. The classification as Type A or B is based on the nature of the leased asset, as follows:
- If the underlying asset is not property (defined as land or a building, or part of a building, or both), a lessee would classify the lease as a Type A lease. However, if the lease term is for an insignificant part of the total economic life of the underlying asset (discussed later in this summary) or the present value of the lease payments is insignificant relative to the fair value of the underlying asset at the commencement date (defined as the date on which a lessor makes an underlying asset available for use by a lessee), it would be classified as a Type B Lease. If the lease is determined to be a Type A lease, a lessee would:
- Recognize a right-of-use asset and a lease liability, initially measured at the present value of lease payments.
- Recognize the unwinding of the discount on the lease liability as interest separately from the amortization of the right-of-use asset which is to be amortized on a straight-line basis, unless another systematic basis is more representative of the pattern in which the lessee expects to consume the right-of-use asset s future economic benefit.
- If the underlying asset is property, a lessee would classify the lease as a Type B lease. However, if the term of the lease is for the major part of the remaining economic life of the underlying asset or the present value of the lease payments account for substantially all of the fair value of the underlying asset at the commencement date, it would be classified as a Type A Lease. If the lease is determined to be a Type B Lease, a lessee would:
- Recognize a right-of-use asset and a lease liability, initially measured at the present value of lease payments.
- Recognize a single lease cost, combining the unwinding of the discount on the lease liability with the amortization of the right-of-use asset, on a straight-line basis.
3. This PASU does not specifically define the insignificant portion of the economic life or economic benefit embedded in the underlying asset, but it does provide certain examples in the background section, such as: If a lessee leases a car for three years and that car has an economic life of seven years, the lessee would be expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset. Alternatively, a lessee leases two floors of an office building for two years and that building has an economic life of 50 years, the lessee is consuming an insignificant portion of the economic benefits embedded in the underlying asset.
4. When measuring assets and liabilities arising from a lease, a lessee would exclude most variable lease payments (defined as payments made by a lessee to a lessor for the right to use an underlying asset that vary because of changes in facts or circumstances occurring after the commencement date, other than the passage of time). In addition, a lessee and a lessor would include payments to be made in optional periods only if the lessee has a significant economic incentive to extend the lease or terminate the lease.
5. For leases with a maximum possible term (including any options to extend) of 12 months or less, a lessee would be permitted to make an accounting policy election, by class of underlying asset, to apply simplified requirements which would be similar to existing operating lease accounting.
6. An entity would be required to provide expanded disclosures to meet the objective of enabling users of financial statements to understand the amount, timing, and uncertainty of cash flows arising from leases.
The comment period for this PASU ends September 13, 2013.
From the date the proposed guidance becomes effective, lessees are to recognize and measure leases at the beginning of the earliest period presented using either a full retrospective approach or a modified retrospective approach. A full retrospective approach would require a lessee to calculate the carrying amounts of all outstanding leases individually at the date of transition as if those leases had always been accounted for in accordance with the proposed guidance. With the modified retrospective approach, a lessee would calculate lease assets and liabilities in a manner similar to the full retrospective approach, but the lessee would be allowed to use information available at the date of transition and would be able to calculate a discount rate on a portfolio basis for leases with similar characteristics, rather than calculate a specific discount rate for each individual lease. An effective date has yet to be established.
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