Perspectives: New Lease Guidance

The FASB and IASB issued a revised Leases exposure draft on May 16, 2013, which would mark a significant change to the current accounting for lease transactions. This guidance could potentially have implications that would impact multiple areas of the business, including treasury, operations, tax, regulatory compliance and decisions on how transactions are financed.

WHAT ARE THE PROPOSED CHANGES?
Under the revised Leases exposure draft, virtually all leases will have to be recognized on the balance sheet. Companies will no longer be able to recognize operating leases off-balance sheet.

When entering into a lease arrangement, or upon adoption of the new guidance, lessees will be required to recognize a right-to-use asset and a liability measured at the present value of future lease payments. As a concession, the FASB will allow companies to make an accounting policy election for short-term leases (less than one year) to be accounted for in a manner consistent with the current accounting for an operating lease.

Leased assets will be bifurcated into “property assets” (defined as land, buildings and part of a building) and “non-property assets” (which could be anything that is not land and buildings, such as machinery).

The lessor will derecognize a non-property leased asset and in its place will recognize a receivable and a residual asset. Most property assets will continue to be recognized by the lessor. It will not be uncommon for both the lessee and the lessor to have a leased asset, especially property leases, recognized on both companies’ balance sheets.

The lessee will recognize non-property lease expense using the dual expense recognition method, which requires recognition of interest expense for the unwinding of the present value discount and depreciation of the right-of-use asset as separate line items on the income statement. The lessor will recognize a portion of the profit from the “sale” of the non-property lease at commencement and recognize interest income over the lease term. Property lease expense/income would be straight-lined over the lease term.

After the initial lease assessment, companies will have to reassess and remeasure the lease assets and liabilities to reflect revisions in estimated lease terms and variable lease payments.

WHAT SHOULD COMPANIES BE DOING TO PREPARE?
Companies should begin to develop accounting policies for analyzing whether existing and new leases would be classified as either a non-property or property lease. For entities with large numbers of leases this could be a significant undertaking. Additionally, companies should develop models to calculate the present value of lease payments for their identified leases. From a controls perspective, companies should begin to develop controls to monitor changes in estimates and begin to develop processes to remeasure the assets and liabilities.

Any arrangement that is affected by a Company’s balance sheet should be reviewed for the impact of this new guidance. For example, companies should begin to evaluate debt with covenants that relate to debt-to-equity ratios or total debt amounts and develop a plan to model the impact of this proposed guidance to creditors. Keep an eye on the news! FASB and IASB deliberations are ongoing so changes to the exposure draft could come at any time. While an effective date is unlikely before 2017, now is the time to start thinking about these potentially widespread and long-lasting effects.