Accounting Standards on Accounting for Leases

Wendy Reedy

The exposure draft has been issued and the comment period is over. The comment letters received identified several matters the FASB and IASB recognize require significant consideration.

The “right-of-use” model proposed in the exposure draft

Under the proposed rules in the exposure draft, the balance sheet will reflect the lease obligation and the “right-of-use” as an asset. The obligation will be measured at the discounted present value of the lease payments and the asset at the present value of the lease payments plus initial direct costs incurred by the lessee. Existing operating lease accounting rules require even rent expense recognition over the lease life. Under the proposed rules the “right-of-use” asset will be amortized using a straight line method, while the obligation will be amortized using the effective interest method. The end result is higher expense recognition in the early life of the lease, decreasing in an effective interest method amortization pattern.

Significant items identified in the comment letters

The comment letters identified the potential lack of symmetry in the accounting by the lessee and lessor for the same lease contract. The exposure draft requires the “right-of-use” model to be applied consistently by all lessees, but proposes the application of that model by lessors depends on an assessment of whether the lessor retains exposure to significant risks and benefits associated with the leased asset. The FASB and IASB have noted the benefit of considering lease issues from the perspective of both the lessee and lessor.

The comment letters also identified the exposure draftÕs potential accounting misrepresentation by requiring one accounting model for transactions with differing substance. It was noted; “Some lessees and lessors enter into lease contracts to finance the use of an underlying asset, whereas other lessees and lessors enter into lease contracts for other reasons, such as the operational flexibility provided by the contract.” As a result, the FASB directed the staff to explore whether there should be two approaches to apply the “right-of-use” model by both lessees and lessors, resulting in two different patterns of profit or loss recognition, and how to differentiate between the two approaches. The anticipation is that a lease considered a financing lease will require the accounting proposed in the exposure draft “right-of-use” model. Lease contracts not considered a financing lease would require the same balance sheet treatment, however, amortization of the obligation would be on a straight-line basis.

Anticipated Timing

To date the joint FASB and IASB deliberations have focused on clarifying the scope of the literature. The FASB and IASB are scheduled to deliberate on the “right-of-use” model on Wednesday, March 2. The release of the final lease literature remains scheduled for mid 2011 while the required implementation date has not been decided. Practitioners are expecting the required implementation date will not be earlier than quarters and years ending in 2013.