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Lease accounting update: Potential changes to current guidelines

Changes to lease accounting standards are coming. Here are some of the topics

The convergence of lease accounting guidelines from the Financial Accounting Standards Board and the International Accounting

The convergence of lease accounting guidelines from the Financial Accounting Standards Board and the International Accounting Standards Board has been an ongoing process for the last few years. The two agencies have been negotiating ways to align U.S. reporting standards with international reporting standards to better reflect the liabilities of a lease on corporate balance sheets.

Specifically, the FASB and IASB intend to shift classification of leases from operating to capital. Operating leases are written off during the year as a business expense, while capital leases are treated more as a purchase. According to a recent analysis from the Rochester Business Journal, the impacts of this change would vary greatly. Manufacturing businesses that own most of their facilities would see little impact, while retailers and service providers that lease multiple locations could see a major increase in long-term debt, the Journal reported. These are some of the specific changes the FASB and IASB have discussed:

Amortizing the asset

At their most recent meeting, the FASB and IASB outlined two potential approaches to amortizing leased assets, also called right-of-use assets.

Underlying asset approach: In this scenario, the asset would be amortized based on its estimated consumption over the term of the lease. If the asset has a high rate of consumption, income statement effects would resemble a financed property purchase. Conversely, an asset with a low consumption rate would more similarly resemble a rental expense.

Interest-based amortization approach: In this scenario, the asset would be amortized in a way that reflects the potential consumption of future economic benefits "for those leases for which substantially all of the risks and rewards of the underlying leased asset have been transferred to the lessee." Leases that do not transfer risks and rewards would be reported more like a traditional rental expense.

Whole contract method 

The Equipment Leasing and Finance Association has had a vested interest in the outcome of the FASB/IASB lease accounting negotiations since they began. The group recently announced one of its suggestions has been taken under consideration by the two agencies: the "whole contract method."

“The whole contract approach considers the [leased] asset and the lease liability that arise from a lease contract to be one unit of account when initially and subsequently measuring those balances," according to outreach information provided by the FASB/IASB staff. "This approach views the [leased] asset as being different from other non-financial assets and different from the underlying asset itself. This is because the [leased] asset is inextricably linked to the lease liability, not only at lease commencement, but also throughout the lease term. This approach also does not view a lease contract as a financing transaction.”

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