Since 2010, the U.S. Financial Accounting Standards Board and International Accounting Standards Board have debated the merits and mishaps of lease accounting. As a result, these boards proposed new accounting rules for leased assets. The proposed changes promise to significantly affect balance sheets and inspire continued debate among legal teams, finance executives and auditors. Reasons behind the ongoing debate include ambiguities within the proposed regulations and the potential negative effects on some companies' financial performance.
Under current lease accounting principles, a lease, which typically grants use of property, goods or services in exchange for periodic payments, is considered either a capital lease or operating lease. Capital leases require a company to add leased assets, such as real estate, vehicles and other equipment, to its balance sheet as a capital asset. Operating leases appear as an operating expense. Under the proposed lease accounting rules, companies need to list billions or even trillions of dollars in new assets as liabilities on their corporate balance sheets. The additional capital burden could potentially lower debt-to-equity ratios and other financial performance indicators.
The proposed regulations would classify the majority of existing capital leases as Type A and the majority of current operating leases as Type B. However, some lease accounting classification decisions will be required. One complication is that some terms are left undefined and subject to interpretation. For example, part of the decision process in properly classifying a leased asset as property or equipment involves an evaluation of that asset's economic life or economic value. If the lease is determined to consume an insignificant portion of either, it qualifies for Type B treatment as an operating expense. Allowing each company and each CPA to decide what constitutes "insignificance" will likely lead to future disagreements, particularly when the asset in question has significant monetary value.
The proposed lease accounting changes arrive at a time of other significant changes to tax regulations and real-life accounting issues. The combination and collision of so many important regulatory changes heightens most companies' concerns and increases the need for proper preparation and advanced planning. Be aware of the possible implications of these new lease accounting standards so you can better counsel your clients and guide accounting strategies that comply with the regulations and optimize companies' financial positions.
Both national and international lawmakers continue to battle over details large and small in their challenging undertaking to remodel global principles and methods for companies' lease accounting. These proposed regulations will require scrutiny as you and your clients evaluate their effect on leasing decisions and financial statements. You are advised to not wait for final issuance, but instead begin reviewing all leaseholds and contracts so you are better prepared for changes in the future.
(Photo courtesy of Jeroen van Oostrom / freedigitalphotos.net)
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