CFOs of companies that lease equipment or retail space may have to wait a little longer for more clarity on how their staffs should account for leases on their balance sheets.
The Financial Accounting Standards Board (FASB) recently extended the launch of its revised exposure draft on lease accounting in February until sometime in early May. But lease accountants and other executives say the draft could even be pushed back further into June.
Corporate accountants and lawyers agree that leases of over one year in duration should be accounted for on a company’s balance sheet. But they continue to disagree on how to recognize equipment and real estate lease obligations on a firm’s income statement. As it stands now, the FASB exposure draft has gray areas: specifically, about how to account for leases of multiple assets and what to do if a lease has both real estate and equipment components.
Such nuances of lease terminology matter. If the draft, as it stands, is accepted by FASB and the International Accounting Standards Board (IASB), that could mean a lot more work for the finance and accounting staffs of companies who lease equipment, notes Bill Bosco, president of lease-accounting firm Leasing 101. “It means keeping two sets of records, one for tax compliance (with property tax law) and to give data to lenders/analysts, and one for the [accounting standards] boards’ proposal,” he says. (Under the boards’ proposal, corporations would have to capitalize all leases. To comply with property tax law, however leases must be identified as either capital or operating.)
In the event of a company’s liquidation, for example, figuring out how to comply with the current lease accounting proposal could be particularly challenging for CFOs and other senior managers of companies who lease equipment, says Bosco.
Under the proposal, some leases are considered to be debt, which would survive a bankruptcy. Bosco and others, however, believe that the lessee lease liability should not be classified as debt. Increasing the lessee’s debt in this way has the potential to alter a corporation’s debt covenants, potentially alienating lenders.
Yet for some leases in bankruptcy, a leased asset would be returned to the lessor, Bosco maintains. If there is no further asset to consider, there is thus no further liability that exists for the lessee. In that case, the lessee’s debt would be removed.
FASB and the IASB agreed on two approaches last June for accounting for leases on corporate income statements. Some leases, such as real estate leases, would qualify for straight-line expensing (in which a single lease expense is recognized over the life of a lease), and other leases, such as equipment leases, would be accounted for in a front-loaded manner (in which larger interest charges occur at the beginning of a lease than at the end).
The boards also agreed that lessees should distinguish between equipment and property leases on their income statements by determining if the lessee acquires or uses up more than an “insignificant” portion of the underlying asset. If a lessee buys or consumes more than that amount, the lessee would have to account for its cost on a property-lease basis; if less, than the arrangement would be deemed to be a lease for equipment.
To Bosco, the exposure draft is “inaccurately portraying the economic effects of a lease,” since some leases (such as capital leases) transfer rights of ownership for lessees, while others transfer only the right of use (such as operating leases). Instead of looking at the contract itself, Bosco notes, the boards are looking at the underlying assets to decide how companies should account for the contract. Since the boards have a different classification test for lessees based on the type of asset leased, Bosco says it is not logical. “One principle should be applied to all leases.”
But getting everyone to agree on lease accounting is a tall order. A Grant Thornton International Business Report in January showed that out of 3,450 global businesses surveyed, 58% either did not support the new lease accounting standards or were undecided about the standards, while the remaining 42% did support it.
The leasing project began with an exposure draft published in 2010 and a great deal of discussion has followed it. When the draft finally is issued as expected this quarter, it will be put out for public comment for a period of 120 days which would presumably end in September, according to a FASB spokesperson. In that case, the revised standard would be issued in 2014.