Leases Headed for the Balance Sheet

The upcoming joint FASB/IASB exposure draft on lease accounting will put an end to off-balance-sheet treatment for leases, while throwing in some new complications.

Equipment leasing is finally on the upswing. The volume of new commercial-equipment leasing rose 15% in April, compared with the same period in 2009. That’s the first year-over-year increase seen in the $518 billion equipment-finance market since July 2008, according to the Equipment Leasing and Finance Association, which released its latest data on Tuesday. Month-to-month volume was up too, rising 9% to $4.7 billion. The uptick is “a positive sign that businesses are starting to invest in capital assets,” says ELFA president William Sutton.

But while the rising tide is welcome, accounting for leased equipment, as well as leased property, may soon become more complicated. The Financial Accounting Standards Board and the International Accounting Standards Board are rewriting the rules on lease accounting, and the exposure draft of their converged standard is scheduled to be released in June. The project is a contentious one: based on their reading of the preliminary discussion paper, finance executives have described the proposed new rules as “onerous” and “complex,” two traits that the standard-setters have worked hard to purge from accounting rules as they rewrite them.

The new standard will replace FAS 13 in the United States and IAS 17 in countries using international financial reporting standards. Essentially, it erases the distinction between operating and capital leases and pulls all leases back on the balance sheet, says Jay Hanson, national director of accounting at McGladrey & Pullen.

The proposal does this by eliminating the so-called 90% rule. Currently, if the present value of lease rental payments amounts to more than 90% of the asset, the contract is considered a capital lease and the asset and liability are placed on the lessee’s balance sheet. If the payments amount to less than 90% of the asset’s value, the lease is considered an operating lease and the lessee simply records the payments as expenses on the income statement.

(Lessor accounting rules will also be addressed in the exposure draft, but it is unclear what changes to existing rules will be presented, as the boards were handling lessee and lessor accounting separately during deliberations.)

“In one sense, some parts of this project make the accounting easier,” comments Hanson, because companies won’t have to spend time figuring out if a transaction is an operating or capital lease. But then, he adds, complexity “creeps in.”

Complication No. 1: Renewal Options

Lease renewal options are one area of contention. Under existing rules, a company uses the minimum lease payment to calculate the present value, and posts that number to the balance sheet. However, under the proposed rule, management must make a judgment regarding what is the most “likely” lease term, and that means considering any renewal options attached to the lease. Since companies negotiate such options because they are unsure of what they will be doing at the end of the lease term, that uncertainty would now have to be factored into assets and liabilities that wind up on the balance sheet, points out Mindy Berman, managing director of corporate capital markets at Jones Lang LaSalle, a real estate service provider.

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