Published October 28, 2010

Upcoming Changes to the Accounting for Leases

Earlier this year, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued “Discussion Paper, Preliminary Views, Leases” (the DP) for public comment. The DP is the first step in establishing an exposure draft for a new accounting standard. The DP discusses various criticisms of the current accounting for leases by lessees, and provides a framework for a new approach in accounting for them. Lessor accounting is still under consideration and subject to further analysis.

Under the existing model, operating leases and capital leases could be similar in substance, but accounted for differently. Currently, capital leases are accounted for by recording an asset and a liability at the present value of the rental payments. Operating leases are accounted for by recording an expense as the lease payments are made, and do not record an asset or liability on the financial statements.

The model proposed by the FASB and IASB would call for many changes to the process of accounting for leases. Under the new model, operating leases would no longer exist; all leases would be accounted for with the recognition of an asset and a liability. An amortized cost-based approach would be used for subsequent measurement of the lease. In addition, the lease term would be determined under a “most-likely” approach, using reasonable and supportable assumptions, not to include the lessee’s intentions or past practices. This new model would also require the lessee to reassess the lease term at each reporting date on the basis of any new facts or circumstances. Finally, this model would require a change in the method of accounting for contingent rental agreements. Currently, contingent rent is expensed as it is incurred. The new model would require contingent rentals to be recorded as a liability on a “most-likely” basis.

While an exposure draft of the proposed standard will not likely be issued until 2010 and a final standard will not likely be issued until 2011, it is important to follow these developments closely as leases are common to most every organization. In addition, the proposed standard would require more bookkeeping for leases held and that organizations carefully consider how leases should be treated when calculating debt covenants.

If you would like more information, please contact the expert listed below at (800) 270-9629.

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