Lease Accounting Update January 2013: Lease Components in a Single Lease Contract

The FASB and the IASB (“The Boards”) met on January 30, 2013 to continue further deliberations on the Lease Accounting Project. The discussions were narrowly focused on the instances where multiple lease components are contained in a single lease contract. As examples, multiple pieces of equipment could be leased under a single lease contract, a single lease contract could contain both property and non-property components or land and building(s) could be leased under a single lease contract.  The central issue discussed revolves around whether individual lease components in a single lease contract must be accounted for separately. The Boards tentatively concluded that for components that are distinct from other goods and services in the lease contract and the components are not customized to meet the particular needs of the customer, those distinct components should be accounted for separately. A single lease that contains components (for example, property and non-property) that are customized and integrally related would be accounted for as a single lease contract. Land and building(s) contained in separate lease contract would be treated a single component and would not be allocated (a difference from current GAAP treatment).

For a lease contract that contains both property and non-property and must be accounted for as a single component, an additional issue deliberated was which lease classification test would apply in these circumstances. The Boards tentatively concluded that the lease classification of the primary (predominant) asset would determine the lease classification. Therefore, if the equipment was deemed to be the primary asset, the presumption would be that the accelerated amortization method would be used whereas if the property was deemed to be the primary asset, the straight-line method would be presumed to apply.

From the previous example, it is clear that any technology solution that a lessee chooses to employ to comply with the new lease accounting standard should be capable of tracking and accounting for both property and non-property (equipment) components. We at iLeasePro have anticipated this need and are developing our lease management and accounting technology product as an integrated solution for both property and equipment.

The Boards additionally indicated that they plan to issue a revised Exposure Draft (“ED”) by the end of March 2013 which will be open for comment for a period of time. Redeliberations and discussion of comments on the revised ED will begin in the second half of 2013.

Importance of Documentation and Compliance

We all know that documentation and compliance has become extremely important in our current business environment,i.e., clear and complete explanations as to why certain actions or changes have been made and the ability to identify the source of those changes. But sometimes it can be time consuming and difficult to provide the documentation and  identification of responsibility that is necessary, even when a technology product is being used. When we were designing iLeasePro, our technology solution for Lessees, we anticipated the need to address these issues and incorporated two user friendly features into our product that facilitate documentation and compliance.

The Notes feature allows the user to add a notation on any page within the application that can provide critical additional documentation and explanation. It is easy to use – just bring up the Note, insert your explanation and it is attached to that page and there for any user to reference.

The Change History feature identifies any addition, deletion or modification made to the original lease information input into the application. This feature stores and reports those changes, identifying the timing and the individual responsible for the entry thereby facilitating audit and management review.

Technology solutions must evolve and be designed to meet the current requirements of the marketplace. These are just two examples of how iLeasePro is meeting the demands of the marketplace.

Lease Accounting Update December 2012

There has not been much mention over the last few months about the FASB and IASB Boards (“the Boards”) Joint Project which would result in significant changes in the manner in which leases are accounted for. The Boards have instructed the staff to revise the Exposure Draft to incorporate the tentative conclusions that have been reached by the Boards. The revised Exposure Draft is expected to be issued in the first quarter of 2013. Interested parties should review the revised Exposure Draft carefully to evaluate the changes to the original document, however, we believe  that most of the controversial issues have been discussed and agreed to by the Boards. All leases, except short term leases, will have to be reflected on the balance sheet of lessees and amortized in one of two ways, depending primarily upon the nature of the underlying asset being leased. The key consideration for the amortization method to be used would involve whether the lessee acquires or consumes more than an insignificant portion of the leased asset over the lease term. The presumption is that leases of property would be classified as straight-line leases unless there is evidence that a major portion of the property is consumed by the lease. Conversely, leases of equipment would be presumed to have accelerated amortization unless there is evidence that only an insignificant portion of the leased equipment is consumed.

Due to lack of visibility about these proposed changes over the last few months, it is easy to overlook the significance of the changes and the potential impact that they will have on lessees’ financial statements. The Boards have not provided any guidance on the proposed effective date for these changes; we hope that the revised Exposure Draft will provide additional insight on this issue. But going forward, lessees should keep in mind that any lease that commences in 2013 and has more than a five year term will probably have to be reflected on the lessees’ balance sheet at the time of the adoption of the new accounting standard.

February 28-29 2012 Joint FASB/IASB Board Meeting Update

The FASB and the IASB Boards (“the Boards”) met at the end of last month to discuss the status of the 2010 Exposure Draft (“the Exposure Draft”) on changes to lease accounting. The majority of the discussion centered on the lessee accounting issue. As has been the case in past meetings, the Boards again reaffirmed their commitment to institute an accounting model requiring that the vast majority of lease liabilities be recognized on the balance sheet. The focus of the discussion in this meeting was on the manner in which lease related expense is recognized and the concerns raised by a number of constituents regarding the accelerated expense recognition pattern which is contained in the Exposure Draft.  Unfortunately the Boards did reach any final conclusions and requested that staff engage in further industry outreach. However, there was some consensus that constituent concerns should be addressed and certain alternatives were discussed.

One approach discussed would reintroduce the concept of operating versus finance type leases into the analysis. For those leases that have operating lease attributes, a new type of amortization model would be utilized that would result in a smoother expense recognition pattern and might approximate a straight-line amortization, depending upon variables such as free rent periods and step rents. For those leases that have finance type lease attributes, the amortization method contained in the Exposure Draft would be utilized.

A second approach discussed would introduce another new amortization model which would consider the consumption of the underlying asset during the term of the lease. This method would depend heavily on the fair value of the underlying asset and the estimated decrease in value of the asset during the term of the lease.  In those situations where the fair value of the leased asset did not decrease or deceased slightly, the amortization expense would be higher in later periods and therefore the total lease expense would be smoother. This could be the case for many real estate leases. In those situations where the fair value of the leased asset decreased significantly, the amortization expense would be more straight-line resulting in an accelerated expense pattern. This could be the case for many equipment leases.

Our View

In attempting to address constituent concerns regarding expense recognition, the Boards have suggested approaches which, in essence, would add complexity, subjectivity and additional cost to the amortization calculations. In some instances, such as fair value estimates, lessees simply would not have the information available to them to make the required calculations. We believe that the feedback that the staff will receive to these approaches will not be positive. The Boards are scheduled to address the issues again in their April meetings and we strongly suggest that interested parties monitor future developments. It seems clear that a revised exposure draft will not be issued until the third quarter of this year.

In a related development, a survey was recently issued by CFO Publishing LLC which gathered responses from 179 senior executives on their plans for dealing with the proposed changes in lease accounting.  The responses are consistent with previous posts that we have entered on our Blog. Concerns were expressed regarding the impact on key financial ratios, costs associated with complying with the new accounting standard and business issues related to lease terms and lease versus buy decisions. Two additional key points were made. First, up to 65% of the respondents expect that moderate or substantial changes will have to be made to financial and operating IT systems. And second, only 10% of the respondents believe that they are adequately prepared for the changes at this point. Although there are still issues to be addressed before finalization of the new standard as indicated above, it is critical that companies begin now to prepare for the new standard by making a comprehensive inventory of all leases and capturing critical lease data in a manner that will facilitate review of this information and completion of the required calculations. For the vast majority of companies, this is not the type of analysis that can be completed and maintained on a spreadsheet.  Begin now to assess your particular situation and the system enhancements that will be necessary to address the business and financial issues that will inevitably arise.

Watch for a Revised Exposure Draft

The revised Exposure Draft on Lease Accounting should be issued in the near future. All interested parties should be prepared to review it and react to the revisions as quickly as possible. The FASB and the IASB have continued to discuss some major changes from the original proposal. Balance sheet recognition of other than short term leases should remain in place but we will want to review changes to issues such as the pattern of expense recognition. Other especially important issues will involve the proposed implementation date and how existing leases will be transitioned into the new accounting model. This revised document should provide a reasonably final  roadmap to the new accounting model.

Update on July 2011 Lease Accounting Activities

In their July 2011 meetings, The FASB and the IASB (the Boards) decided to formally re-expose the proposed lease accounting standard for public comment. The timetable for final issuance will be pushed out even further into the future. The Boards’ goal is to finish final deliberations in the third quarter of 2011 with the issuance of a revised exposure draft shortly thereafter.  It is likely that the final standard would not be issued until the second half of 2012.

The Boards continue to reaffirm previous tentative decisions related to accounting for short-term leases, variable lease payments and subleases. The Boards also expanded the scope of disclosure requirements in the area of maturity analysis and expense component disclosures.

With respect to lessor accounting requirements, the Boards developed an approach for lessor accounting that is different from the approaches put forth in the original exposure draft. This new approach, called the “receivable and residual approach”, would require balance sheet presentation of the lessor’s right to receive lease payments and would allocate the carrying value of the leased asset between the portion related to the right of use asset and the portion retained by the lessor.

Our View

Although the time table for final issuance of a new accounting standard has been extended even further, the basic principles related to proposed lessee accounting continue to be reaffirmed, namely, a balance sheet approach with the need for significant upfront calculations, reassessment of original conclusions under certain circumstances and an acceleration of expense recognition as compared to current GAAP accounting. The delay in issuance is mainly due to the Boards’ position that the new standard deal with both lessee and lessor accounting and the reconsideration of lessor accounting as compared to the proposals in the original Exposure Draft. The model now proposed for lessor accounting will be significantly more complex than the current GAAP requirements.

Lessees should continue to follow the approach that we have outlined in the past by making certain that critical lease information has been collected and organized in a manner that will facilitate the analysis required not only to meet the new accounting standards but also to satisfy business needs of the enterprise. For even a relatively small portfolio of leases, an easy to use technology solution is essential.

Headlines from the Latest FASB/IASB Meetings

The issuance of the final standard for lease accounting will likely be delayed until the first half of 2012. At the least, there will be another draft version of the new standard made available for review and comments. There still has not been any decision made regarding the effective date of the new standard.

The Boards continue to reaffirm balance sheet recognition for most leases.

Current operating lease accounting can continue to be used for short-term leases. Short-term leases are defined as those which have a maximum possible lease term, including any options to renew, of 12 months.

Except in limited circumstances, non-lease components, including payments for services and executory costs (insurance, taxes and maintenance), would be separated from the lease payments and would be accounted for similarly to the way that they are currently.  The allocation between lease and non-lease components would be a new process for many lessees and may require significant judgment.

The determination of the lease term is critical. Currently, the lease term is defined as the non-cancelable period, plus any options periods where there is a significant economic incentive for the lessee to extend or not terminate the lease.

Changes in certain circumstances would require reassessment of the original accounting judgments. Reassessment would be required if the conclusions reached on lease term and purchase options, among other things, changed based upon changes in the original conclusions regarding significant economic incentives.

The Boards reaffirmed their position that contingent rent based upon performance or usage would be charged to expense as incurred.

Our View

This project continues to progress, albeit at a much slower pace than originally projected.  Although some of the complexities contained in the original Exposure Draft have been eliminated, the basic principle of balance sheet recognition for all leases (except short-term leases) has been maintained. There are still a number of areas that will be complex and subjective to apply, including determination of lease term, non-lease components and the requirements to reassess due to certain changing conditions. Companies will have to develop processes and procedures that will allow them to review lease terms, identify critical dates and reassess original conclusions. Having comprehensive lease information readily available is crucial. We continue to believe that the technology tool that we are developing will provide the user with the critical data that is necessary not only to meet the needs of this new accounting requirements but just as importantly to manage the lease portfolio in an efficient and effective manner.

Lease Management and Accounting Tool

We have some exciting news to share with all of our readers.  iLease Management LLC will soon launch a lease management and accounting tool that will meet the critical needs of lessees as they react to the new lease accounting standards and continuously try and gain efficiency in their day to day operations.  As we have emphasized a number of times in the past few months, an accounting change of the nature being proposed provides a perfect opportunity to review and improve operating procedures.  We are confident that we are developing a technology solution that will accomplish that objective.  Some of the features and capabilities of this tool are as follows:

  • Dashboard – provides the user with the capabilities to see a high level view of all lease portfolios and critical dates.
  • Property – provides key property metrics and details.
  • Unit – drills down another level to provide critical unit level details.
  • Lease– captures important lease information that will facilitate effective lease management.
  • Rent– provides all critical rent information including base rent, free rent and rent steps.
  • Insurance – captures key insurance information.
  • Lease options – allows the user to effectively monitor option terms and conditions.
  • Accounting – using the information that has been previously input, the accounting feature automatically generates the accounting entries that will be required under the new accounting standard, both by individual lease and in the aggregate.  The user can export these transactions and is then ready to post these entries to the general ledger.
  • Reporting – a full suite of Lease Management and accounting reports

Additionally, the user will have the capabilities to capture key information on retail leases, maintain critical contact information, define critical dates, add specific and customized information on unique lease options and clauses and attach images and key documents.

As you are aware, we are monitoring the FASB/IASB activities and developing the accounting solution to be consistent with the new standard. We expect the tool to be available as soon as possible after the new standard is released.  We have been working on this project for a number of months and will keep you updated on our progress.  Our product will make a significant improvement in your operations.

In the meantime, we are interested in your comments and feedback.  Please update the Blog with your questions, comments and needs for additional information. Additional information can be found on the iLeasePro homepage.

Action Plan for Lease Accounting Changes

As we have been discussing for a number of weeks, there are major changes that are being proposed in the accounting for leases for both lessees and lessors, with the major emphasis initially being directed to the lessee community. The result of these changes will be the elimination of the operating lease form of accounting, except for possibly shorter term leases of less than twelve months. In its place will be an accounting standard that would require that all lease obligations be reflected on the balance sheet with an offsetting asset for the right to use the leased space. Although the release of the final standard has been delayed until latter half of 2011, we believe that it is extremely important for those organizations that will be impacted by this new accounting to develop an Action Plan to monitor and assess the impact of these proposed changes.

Here are the key steps that we believe are necessary in order to develop a meaningful Action Plan for Lease Accounting Changes:

  • Ensure that all relevant internal parties are involved in the evaluation. In addition to the department that has primarily responsible for leasing, operating management may need to be involved in the assessment of renewal options and percentage rents and the finance function must be involved in the determination of any CPI provisions in the leases and the incremental borrowing rate to be utilized in the calculations.
  • Ensure that all legal documents supporting lease agreements are collected in one central location(s) and summarize the key information from the leases as follows:
    • Lease terms and related rental amounts
    • Renewal option terms and related rental amounts
    • Any contingent rentals provisions
    • Any percentage rental provisions
    • Residual value guarantee or termination penalty provisions
    • Service elements contained in leases
  • Assign responsibility for monitoring changes to the original proposal as it goes through the deliberation process. As concerns have been raised about the complexity and subjectivity of the original proposal, the FASB and the ISB have tentatively agreed to make changes to the original proposal in certain areas such as renewal options and percentage rents. These changes will help to alleviate some of the objections that have been raised but there is still a substantial element of uncertainty involved. It is critical that these changes be monitored and incorporated into the overall assessment of the proposed standard.
  • Understanding that the tax accounting for lease payment will not change and therefore there will be temporary differences between GAAP and Tax accounting that will result in additional deferred tax impacts. The finance function should be actively involved in assessing these implications and any tax planning strategies that may be undertaken.

Although the economics and cash flow of leasing decisions will not change, the entire organization should be aware of the material financial implications that may result from this accounting change. Profit and loss expense charges will accelerate as a result of this proposal. Some estimates have indicated that first year expense charges for a ten year lease will increase by approximately 20%. Additionally, the standard as proposed would require recognition and measurement of all leases outstanding as of the date of adoption using a retrospective approach. Therefore, there will be a significant impact immediately upon adoption. Leasing decisions made currently should take this into account.

  • Shorter term leases would result in a less significant negative financial impact, however, is this appropriate from a business perspective?
  • Should renewal options and percentage rents be eliminated from future leases?
  • How will tenant improvement allowances be impacted?
  • Is it time to reevaluate lease versus buy conclusions that might have been made in the past?

There will be a significant increase in assets and liabilities as a result of the adoption of the proposed standard. Loan covenants and other legal documents that may be impacted by these significant financial changes should be reviewed to determine the implications on financial covenants and ratios such as debt to equity and interest rate coverage.

There is a final thought that we believe is very important to consider. Do not think of this process simply in terms of complying with the new accounting standard. Use this opportunity to evaluate the entire leasing business process and the effectiveness of the procedures and controls surrounding that process. We believe that this is an area that has not received the proper attention in the past.

  • Have the significant terms of leases been summarized and captured in a system that allows the information to be readily obtained and evaluated?
  • Has there been manpower waste and redundancy in the past that should be eliminated?

There is now an opportunity to quantify the value of improved operational practices in the entire leasing process.

  • What about IT systems surrounding the leasing process?
  • Do they exist?
  • Are they adequate to meet the challenges that are presented by the new standard?
  • Remember that the financial implication of each new lease must be evaluated upon execution and reevaluated if there is a significant change in assumptions. Is this an opportunity to build an improved lease management process that will meet both the business and financial (both accounting and tax) needs of the organization?

    There has been no formal decision made about the effective date of the new standard but speculation has centered around 2013. Although this may seem like a significant time span, the effort needed to interpret the requirements as they pertain to each individual organization and complete the evaluation of the lease portfolio will be substantial.

    Now is the time to get started on this project!



iLease Management LLC monitors and reports on the progress of the proposed changes to lease accounting.  The FASB and the IASB issued an Exposure Draft in 2010 which generated a significant amount of controversy among preparers and users of financial statements. The Boards continue to meet to evaluate the more contentious issues and are considering changes to the Boards’ original proposal, particularly in such areas as lease renewal options and contingent rents.  Included is a simplified example of how we expect the current changes to impact the accounting process and reporting for a basic real estate lease.  This example does not take into account many of the more complex and subjective areas of the original Exposure Draft dealing with subjects such as lease renewal options, contingent rents, residual value guarantees and term option penalties.    

To illustrate the impact of the proposed new lease accounting model for lessees, consider the following example:


  1. A four-year non-cancelable lease term:  48 months
  2. Minimum monthly lease payment:  $1,000
    1. Assuming there are no defined lease options, contingent rental payments or residual value guarantee
    2. Incremental borrowing rate:  7%

Calculated Amounts

Present Value (PV) of lease payments = $42,000

Total lease payments over the 48 month term = $48,000

Balance sheet analysis

Under current GAAP Accounting for an operating lease where rent is accounted for in the current period

Existing US GAAP
  At inception End of Yr 1 End of Yr 2 End of Yr 3 End of Lease Term
No asset $0 0 0 0 0
No liability $0 0 0 0 0


Under the proposed guidelines, there is an increase in assets and liabilities.

Proposed Model
  At inception End of Yr 1 End of Yr 2 End of Yr 3 End of Lease Term
Right To Use Asset $42,000 31,500 21,000 10,500 0
Rent Payable $42,000 32,600 22,450 11,600 0


Profit and loss statement expense analysis

Under the proposed model, the right to use asset is amortized to expense over the term of the lease and the rent payable liability decreases as rental payments are made. 

  Year 1 Year 2 Year 3 Year 4
Existing US GAAP        
Rental Expense                                       $12,000 12,000 12,000 12,000
Proposed model        
Amortization of Right To Use Asset $10,500 10,500 10,500 10,500
Interest Expense $2,600 1,850 1,150 400
Proposed Expense $13,100 12,350 11,650 10,900


Accounting entries under the proposed model would be as follows:

  Debit Credit
Accounting by lessee – at inception    
Right To Use Asset $42,000  
Rent Payable                                           $42,000
Accounting by lessee – year 1    
Amortization Expense $10,500  
Right To Use Asset   $10,500
Interest Expense $2,600  
Rent Payable   $2,600
Rent Payable $12,000  
Cash   $12,000


In the profit and loss statement, rental expense under existing US GAAP becomes a combination of amortization and interest expense under the proposed model. Expense under the proposed model is higher in the earlier years of the term of the lease due to interest expense calculated using the effective interest method applied to a declining outstanding balance of rent payable.

In addition to the reporting changes to the balance sheet and P&L report identified above, firms should evaluate the impact to;

  • Current accounting processes
    • Lease Accounting system/software
    • Income tax impact
    • Financial Ratios
      • Increase in EBITDA
      • Return on Assets
      • Debt-to-Equity
      • Interest Coverage
      • Operating Margins
      • Debt covenant compliance
      • Ability to secure financing
      • Integrity of lease information
      • Resources required  

iLease Management LLC will continue to closely monitor and report on the decisions of the FASB/IASB Board meetings on the lease accounting changes.

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