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May 22 2011

Reversal on Lease Classification and Expense Recognition

In our review of the FASB and IASB tentative conclusions reached in April, we noted that the Boards had agreed to introduce two classifications for lessee accounting depending upon whether the lease was considered to be a finance lease or other-than- finance lease. Both lease types would have been required to be recognized on the balance sheet but the other -than-finance leases would have been afforded straight-line expense recognition over the term of the leases as compared to finance leases which would require interest expense recognition using the interest method and amortization of the balance sheet right-to-use asset generally on a straight-line basis.

The Boards have not reversed themselves on the April tentative conclusion and are reverting to the model contained in the original Exposure Draft whereby all leases would be recognized using the finance lease approach with expense recognition consistent with the current GAAP accounting for capital leases.

The Boards also plan to revisit the tentative conclusion reached earlier which would allow shorter terms leases (12 months or less) to be accounted for off the balance sheet.

Our View of this Change

The Boards reversal in this area reintroduces one of the major objections raised in comments letters to the Exposure Draft, namely, that acceleration of expense recognition for all leases does not reflect the economic reality of many lease agreements. If this tentative conclusion remains in place, it also results in a more complex calculation of expense over the lease term for all leases.

This series of events also points out the need to actively monitor the adjustments that the Boards are making to this proposal. Tentative conclusions are just that – tentative. We will continue to monitor these activities and update our postings to reflect the current direction of the proposal.