The Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) issued a Revised Exposure Draft (“ED”) earlier this week proposing major changes to the manner in which lessees would account for their lease contracts. The Revised ED contained a number of revisions to the 2010 Exposure Draft that the Boards originally issued but these revisions will not be surprising to those who have followed the Boards more recent deliberations as we have outlined in our previous Blog postings.
The Boards have retained the requirement that most lease contracts be recorded on the balance sheet of the lessee using a right-of-use model for recording the right-of-use asset and the liability to make lease payments. The calculation of the initial asset and liability would be derived from the present value of the fixed lease payments with the possible inclusion of certain lease incentives, certain variable lease payments, residual value guarantees expected to be paid and certain purchase and lease termination options. The Boards proposed a number of changes to the 2010 Exposure Draft that are designed to reduce complexity including:
- The lessee can make an accounting policy election to apply the current operating lease accounting model for those leases that have a maximum possible lease term of 12 months or less, including option periods.
- The previous requirement to include variable lease payments has been revised to apply only to those payments that are based on an index or a rate or that are in-substance fixed payments.
- The requirement to include payments during an option period has been redefined to include only those payments where the lessee has a significant economic incentive to exercise the option.
- Lease and non-lease components (predominantly services provided by the lessor) would generally be accounted for separately.
A major change from the 2010 Exposure Draft would involve lease classification based upon the nature of the asset being leased and how lease related expenses are recognized.
Leases of assets that are not property (mainly equipment) would be classified as Type A leases unless either the lease term is for an insignificant portion of the leased asset’s economic life or the present value of the lease payments is insignificant versus the asset’s fair value.
Leases of property would be classified as Type B leases unless either the lease term is for the major portion of the leased asset’s remaining life or the present value of the lease payments accounts for substantially all of the asset’s fair value.
Expense recognition for Type A leases would follow the proposal contained in the 2010 Exposure Draft and would result in an accelerated expense recognition in the earlier periods of the lease. For Type B leases, expense recognition would be similar to the straight-line method for current operating leases.
There are two transition approaches being proposed in the ED but neither of these approaches would provide for grandfathering of existing leases. The Boards have not yet proposed an effective date for the new standard but most observers have suggested that there would be an extended implementation period because of the significance of the changes as compared to the current accounting requirements.
The Boards provided for an extended comment period of almost four months (September 13, 2013) and we would expect that there would be a numerous comments and possible revisions as a result of these comments due to the controversial nature of the accounting changes being proposed. We do not expect a final standard to be issued until well into 2014.