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Lease accounting update: New rules on the way

Two agencies recently agreed on a new direction for lease accounting standards

Recently, the Financial Accounting Standards Board and the International Accounting Standards Board convened in London to decide the direction of lease accounting. After years of discussion and negotiation, the agencies finally settled on preliminary rules that will change the way some companies complete their financial reports.

In earlier iterations of the reporting rules, the FASB and IASB wanted organizations to list leased assets as purchases and treat payments as loans. Regulators felt some companies were able to hide their liabilities by not including assets in their reports. An analysis by The New York Times pointed to the example of an airline that leases its airplanes, but does not report those expenses due to inadequate reporting requirements.

Businesses argued this method would exaggerate their costs earlier in the lease period, when payments would comprise mostly interest. In response, the agencies voted to take a two-pronged approach to lease accounting - one that mirrors their original approach, and one the accounts for other types of leases.

Right of use: This approach to lease accounting is similar to the earlier rule. In this scenario, value of the asset would be front-loaded, reflecting an increased percentage of payments that go toward interest. Over the term of the lease, the reported value would gradually decrease.

Payment for access: Lease contracts that do not fall into the right of use category would be reported a different way, reflecting a straight-line accounting approach. Under this scenario, monthly lease payments would be spread out and reported evenly over the life of the agreement.

"The Boards carefully considered the diverse views of stakeholders about whether the income statement profile of all leases should be the same," said FASB Chairman Leslie F. Seidman. "On balance, we decided that leases that convey a relatively small percentage of the life or value of the leased asset should be recognized, evenly over the lease term."

There are still some details the agencies will need to work out before the rules can be implemented. While they had been taking a principles-based approach to accounting standards, the lease accounting agreement will require hard guidelines to help determine which assets fall into the right of use category and which fall into the other category.

"We will publish our proposals for public comment, with a view to completing this important convergence project during 2013," said Hans Hoogervorst, chairman of the IASB.

If you want to learn more about potential changes in lease accounting in addition to financial instruments and revenue recognition, Proformative is offering a webinar, The Ripple Effect: Convergence of Financial Instruments, Leasing, and Revenue Recognition for IFRS and US GAAP, on July 19th. Learn More & Register.

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