Leases: Long Overdue Changes Proposed

The Financial Accounting Standards Board and the International Accounting Standards Board are looking to rewrite current lease accounting standards. In their Discussion Paper Leases: Preliminary Views, the Boards outline conceptual problems with current lease accounting and advance proposals to put operating leases on the balance sheet.

Current lease accounting standards are derived from the view that a lease that transfers substantially all of the benefits and risks of ownership should be accounted for as acquisition of an asset and incurrence of an obligation by the lessee. Other leases should be accounted for as operating leases. Operating leases are treated as rentals of property and the associated assets and obligations are not recognized on the balance sheet.

Many believe that existing standards are conceptually flawed and that operating leases give rise to assets and liabilities that should be recognized in the balance sheet of the lessee. The lessee obtains a valuable right (the right to use a leased item) and this right meets the definition of an asset. Similarly, the lessee assumes an obligation (the obligation to pay rentals) and this obligation meets the definition of a liability.

The FASB and IASB agree that the current rules are flawed and have proposed a new accounting model for leases that will put rights and obligations of leases on the statement of financial position.

There are a lot of details to be worked out including how the new proposals will affect accounting by lessors – the current discussion paper is focused on the rules for lessees. However, the changes proposed to lease accounting standards are long overdue. Lease financing is a significant source of financing for many companies. A new standard will put these obligations on the balance sheet where they belong, giving financial statement users a more complete picture of a company’s financial position.

One interesting aspect of this debate is how long it has been occurring. I went back to my old intermediate accounting text book which was published in 1980. In the last paragraph of the lease chapter, the authors noted that a change in the official view of leases may be forthcoming. They were referring to accounting for lease rights and obligations in the balance sheet. They also mentioned that this view was recommended by AICPA Accounting Research Study No. 4 in 1962.

Do you agree or disagree with the need to rewrite the rules for leases? Let us know what you think.

 

- Paul Parks

Comments

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[Bob Cook]

As we move towards the new lease standards, the realization of the impact is starting to dawn on corporate real estate departments. These standards are going to be pretty significant in their lives. First, by putting lease obligations in the spotlight, corporate real estate departments are going to feel the heat as corporate executives begin to question things like "who's negotiating these leases". Second, own vs lease strategy requires rethinking once leases no longer benefit from being off-balance sheet. And lastly, compliance is going to be challenging. Corporations do not now have the SOX-compliant processes and systems they're going to need to comply with the new standard. It's going to be a whole new world for corporate real estate departments.

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[Vici Hall]

I have worked as a Controller in many different industries... With The Cash Flow Manager who is definitely aware of all lease obligations on a monthly cash outlay position but perhaps not of the magnitude of the obligation and then there's The Balance Sheet Manager who is usually unaware of the total obligation because of the out-of-sight-out-of-mind sensibility. Both types of managers NEED to understand the total obligation and how best to react and plan with regard to their complete obligations. Revealing the asset and liability of all leases will make the obligation impossible to ignore/miss/forget.

[Rich Eyermann]

I agree with including operating leases on the statement of financial position. The rules today for deciding whether the lease is operating or capital lead to misunderstandings and result in inconsistencies in the view of many users of the financial statements. In my opinion, this would plug a significant gap in financial reporting.

[Robert Prator]

I think a revision of lease accounting is long overdue. Every lease produces rights and obligations, although measurement for reporting purposes will pose some interesting issues. The current disclosures for operating leases, while useful, do not give the rights and obligations the emphasis that financial statement recognition would.

[David Reid]

Absolutely. I work for a retail company and when we close a location we have to book a huge liability thanks to FAS146. We also have to book ARO liabilities thanks to FAS143. THe only time we don't have to book a liability is for the monthly rental payments when the store is open. MAkes no sense. It's as much an obligation when open as closed, and notes are fine, but non-accounting management relies on financials too and all too often forget obout the extent of these obligations when making deals, since internal financials don't have formal notes. Getting the obligations into your GL would help them. For investors, Bal Sht needs to properly reflect all rights and obligations you are firmly committed to by contract. Our investors have been unpleasantly surprised at times, which is not good.

[Craig Gibson]

I'm sure that lease accounting needs to be updated, but strongly disagree that every lease should be included on the balance sheet. Whatever happened to the notes being an integral part of the financial statements?

[Robert Knapp]

Lessee accounting for leases needs to be re-written. All leases have a minimum liability obligation. This liability needs to be shown in the Balance Sheet not just the footnotes. If the tangible asset is not being acquired then a right to use is being acquired. This asset needs to be in the Balance Sheet. To avoid excessive effort a mimimum threshold needs to be developed for capitalization.

[paullette allen]

should one insure a building you are renting with expiration in 2013 with an insurance company that is unstable? should only contents be insured? If a hurricane comes and blows it down, who is responsible.

I think insurance and each category of lease should be defined as to who should cover what. Insurance companies are covering these buildings both for the tenant and the landlord. This can't be right.

[Lance R Mann]

I think the lease rules should be written in order to account for each lease based on the intent of the lease. Granted - monthly office leases probably do not need to be capitalized. However, one particular example I can see is how some construction companies will enter into month-to-month leases that renew automatically but if they want to end the lease - they must pay the difference between FMV and what the Lessor owes on the loan. Under current lease accounting - this would be an operating lease but these assets should be capitalized.

[Trevor Shannon]

In my opinion, absolutely all leases should be included on the balance sheet. They are a legal obligation and should be accounted for as any other obligation. Corresponding depreciation on the asset should be over the term of the lease.