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The FASB/IASB Lease Accounting Project

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The FASB / IASB Lease Accounting Project

On August 17, 2010, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) jointly issued exposure drafts on Leases. The Boards undertook the leases project to address the widespread concern that many lease obligations currently are not recorded on the balance sheet and that the current accounting for lease transactions does not represent the economics of all lease transactions. The Boards previously agreed that leases should be recorded on the balance sheet, but have continued to discuss the classification and pattern of expenses in the income statement. Disclosure and transition guidance must also be tackled. Any decisions that have been made to date are preliminary and were sufficiently different from those published in the original exposure drafts to warrant re-exposure with the revised proposals. Accordingly, the Boards plan to release a joint Exposure Draft in the fourth quarter of 2012 with the aim of completing the final standard in 2013.                                                                                                                                                                

As part of the key provisions of the original exposure drafts, lessees and lessors would apply a right-of-use model in accounting for all leases (including leases of right-of-use assets in a sublease) other than leases of biological and intangible assets, leases to explore for or use natural resources, and leases of some investment properties.

With this model, a lessee would recognize 1) an asset representing its right to use the leased asset for the lease term (measured initially at the present value of the lease payments plus any initial direct costs) and 2) a liability to make lease payments (measured initially at the present value of the lease payments).

This differs from current U.S. generally accepted accounting principles and International Financial Reporting Standards, which place leases into two categories: 1) Capital leases (recognize an asset and a liability) 2) Operating leases (do not recognize an asset and liability).

As presented in the original exposure drafts, all leases would result in asset and liability recognition.

A lessor would recognize an asset representing its right to receive lease payments and, depending on its exposure to risks or benefits associated with the underlying asset, would either recognize a lease liability while continuing to recognize the underlying asset (a performance obligation approach) or derecognize the rights in the underlying asset that it transfers to the lessee and continue to recognize a residual asset representing its right to the underlying asset at the end of the lease term (a derecognition approach).                                                                                                

Some of the more significant changes to the original exposure drafts the boards have tentatively agreed to make are as follows.

Dual Approaches - the  boards  are  planning  to  tell  companies  that leases of property— e.g., land, buildings, or some combination—should  be  accounted  for  using  the straight-line  approach (similar to current operating lease accounting) unless the lease term is for the major part of the economic life of the underlying asset or the present value of fixed lease payments accounts for substantially all of the fair value of the underlying assets. For leases of assets other than property, such as equipment, the presumption would be that the lease is a right-of-use lease for lessees and a receivable-and-residual lease for lessors. Therefore, the lease should be accounted for using the approach established in the original exposure draft, which results in a “front loading” of lease expense, unless the lease term is an insignificant portion of the economic life of the underlying asset or the present value of the fixed lease payments is insignificant  relative to the fair value of the underlying asset.

Lease Definition – the FASB and the IASB have agreed to clarify the original exposure drafts' definition of a lease, which was similar to definitions in U.S. GAAP and IFRS. Under  the clarified definition, whether a contract contains a lease would be determined on the  basis of the substance of the contract by assessing whether the fulfillment of the contract depends on the use of a specified asset and whether the contract conveys the right to control the use of a specified asset for a period of time.

Term of Lease - the boards tentatively decided that the lease term should be defined as the contracted noncancellable period plus any option periods for which there is a clear economic incentive for the lessee to exercise the option, or for an entity not to exercise an option to terminate the lease. This differs from the original exposure drafts' definition as the longest possible lease term that is more likely than not to occur, taking into account the effect of any options to extend or terminate the lease.

Short-Term  Leases - the FASB and the IASB have tentatively agreed to give lessees an option similar to the option proposed for lessors; that is, to elect, by class of underlying asset, not to recognize assets and liabilities from a short-term lease (less than twelve months) in the statement of financial position. Lease payments would be recognized in profit or loss on a straight-line basis over the lease term, unless another systematic and rational basis is more representative of the time pattern in which use is derived from the underlying asset.

Sale and Leaseback Transactions - the boards tentatively decided that an entity should apply the control criteria described in their revenue recognition project to determine whether a sale has occurred, rather than the more restrictive criteria proposed in the original leases exposure drafts. The effect is that more transactions would qualify for sale-leaseback accounting than under the original exposure drafts.



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