Decision on lessee model clears way for lease accounting project’s final act

Accounting standard setters agreed Wednesday on a lessee accounting approach, setting the stage for a lease accounting exposure draft in the fourth quarter this year.

The US Financial Accounting Standards Board and the International Accounting Standards Board previously agreed that leases should be recorded on the balance sheet, but have been debating the classification and pattern of expenses in the income statement. They voted Wednesday to support a lessee accounting model with different lease-expense recognition patterns for different leases (with the exception of short-term leases.)

The decision and some related revisions to the lessor accounting model were described by the boards as the last substantive decisions to be made before they re-expose the lease accounting proposals. IASB Chairman Hans Hoogervorst, said in a statement that the boards are now on track to complete the leasing project in 2013.

The dual expense-recognition approach holds that not all lease contracts are the same; therefore some should be treated as the purchase of a right-of-use (ROU) asset, which is financed separately.

Other lease contracts would be treated as payment for access to and use of the underlying asset over time. This approach would link the right-of-use asset and the lease liability through the lease term, according to board documents. The lessee would allocate the total lease payments evenly over the lease term, resulting in straight-line total lease expense. This would occur even if the pattern of lease payments is not equal throughout the lease term. The lessee would present the total payments as lease expense.

“On balance, we decided that leases that convey a relatively small percentage of the life or value of the leased asset should be recognised, evenly over the lease term,” FASB Chairman Leslie F. Seidman said in a statement.

In the right-of-use approach, the lease would be accounted for as a nonfinancial asset and measured at cost, less accumulated amortisation. The combination of the amortisation charge on the ROU asset and the interest expense on the lease liability would result in a total lease expense that would generally decrease over the term of the lease, in other words, a front-loaded expense pattern.

Where to draw the line

After voting on the dual expense-recognition approach to lessee accounting, the boards, meeting in London, turned to discussion of how to determine when the different recognition patterns should be applied. The board ultimately supported two options applicable to lessees and lessors:

• Determination based on whether the ROU asset represents the acquisition of a more than insignificant portion of the underlying asset.

• Determination based on the nature of the underlying asset.

For equipment leases, the presumption would be that the lease is an ROU lease for lessees and a receivable and residual asset for lessors unless the lease term is an insignificant portion of the economic life of the underlying asset or the present value of the fixed lease payments is insignificant relative to the fair value of the underlying asset.

Real estate leases would be accounted for using a straight-line presentation in the income statement unless the lease term is for the major part of the economic life of the underlying asset; or the present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset.

The leases project has been highly scrutinised because of its scope, as a high percentage of companies are involved in leases of some form or another. The boards published an exposure draft in August 2010 and then began deliberations in February 2011 on the project and the feedback received. Last July, the boards decided to re-expose the leases proposals.

Kim Nilsen (knilsen@aicpa.org) is executive editor of CGMA Magazine.