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Impact of Changes in Accounting for Leases Standard

By: Stephanie McGuire

 Overview of the FASB Revised Lease Exposure Draft issued May 2013

As FASB and IASB continue efforts to converge standards, the revised proposal for accounting for leases will impact all companies who have large portfolios of operating leases.  The most significant impact will be that all long-term leases will be recognized on the balance sheet.  The lessee will recognize a new “right-of-use” asset quantifying its right to use the underlying leased asset during the term of the lease.  The lessee will also recognize an obligation to make lease payments, which was previously only required to be disclosed in notes to financial statements.

Lessor models are consistent with current capital and operating leases accounting, however significant judgment continues to be required to determine proper lease classification and measurement.  For both the lessee and lessor, additional procedures will be required to amortize new lease assets, monitor assumptions used, as well as evaluate new lease assets for impairment.

The revised proposal was introduced as a way to simplify the lease classification determination while using the same criteria for both lessees and lessors.  The accounting for all leases under the standard is based upon the underlying asset.  If the lease results in the lessee consuming more than an insignificant portion of the economic benefits of the leased asset, it would be a Type A lease.  Type A leases of equipment and assets other than real property, will follow the financing approach and result in accelerated expense recognition during the earlier years of the lease.  Type B leases of real property (most real estate) will follow the straight-line approach similar to current operating lease accounting.  The initial measurement of the lease asset and lease obligation is the same for both Type A and Type B leases based on the required lease payments over the life of the lease, and discounted for the time-value of money.

What to do now

To prepare for the expected challenges of adopting the new standard, start gathering data now for all leases in order to assess the type of lease as well as calculating the present value of the leased assets.  Accumulate variables such as the discount rate, renewal terms, purchase options, and other variable components of lease payments which will affect the total amount capitalized.  Review all current leases to ensure a complete copy of the lease agreement is maintained and request copies of any missing lease documents.  Once all leases are obtained, extract and summarize relevant data from each lease to begin calculating the new lease right-of-use asset and liability as well as the effect of adoption.  Additionally, it may be a good idea to start discussions with lenders regarding debt covenant calculations.

Click link below for a printable executive summary of the revised lease proposal.

Revisions to Leases Accounting

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