New requirements that will bring lease assets and liabilities onto company balance sheets are expected to be issued in early 2016 after the US Financial Accounting Standards Board (FASB) voted 6–1 Wednesday to send its leases standard for final drafting.
The new standard will include substantial changes to lessee accounting that may require preparers to implement new systems and internal controls and will result in substantial additions of lease obligations to many balance sheets. Lessor accounting will experience less change under the new standard.
When FASB’s staff is finished preparing the final draft of the standard, the board will take a final vote by written ballot.
In addition, FASB voted 4–3 to have the staff prepare a final draft of a new standard for classification and measurement of financial instruments.
Although the leases standard began as a convergence project designed to harmonise US GAAP with IFRS, FASB and the International Accounting Standards Board (IASB) ultimately could not reach agreement on some key issues.
Nonetheless, FASB voted in favour of an effective date that’s similar to the IASB’s, and an IASB spokesman said the board expects to co-ordinate its release of the standard with FASB’s.
FASB’s standard will take effect for public companies in fiscal years beginning after December 15th 2018 including interim periods within those fiscal years. For private companies, the standard will be effective for annual periods beginning after December 15th 2019. Early adoption will be permitted for all organisations upon issuance of the standard.
Highlights of the standard that received preliminary approval from FASB on Wednesday include:
- Right-of-use principle. The basic principle of the standard states that a lease conveys the right to control the use of an asset, creating an asset and a liability for lessees that will be reflected on the balance sheet.
- Type A and Type B leases. Most existing capital/finance leases will be accounted for by lessees as Type A leases, with recognition of amortisation of the right-of-use asset separate from the interest on the lease liability. Most operating leases would be recognised by lessees as Type B, with a single total lease expense. Both types of leases would result in lessees recognising a right-of-use asset and a lease liability.
- Key difference from the IASB. The IASB is moving forward with a single approach for lessee accounting, under which a lessee would account for all leases as Type A leases.
- Lessor accounting. Lessor accounting for US GAAP and IFRS would follow today’s model, as Type A leases will be those that are effectively a financing or a sale, and Type B leases will be operating leases. Under Type A leases, the lease transfers substantially all the risks and rewards incidental to ownership of the underlying asset.
- Short-term leases. Balance sheet presentation will not be required for leases with a term of one year or less.
- Portfolio approach. The boards will permit the leases guidance to be applied at a portfolio level to leases that are similar in nature, age, and value.
The US Securities and Exchange Commission staff recommended in 2005 that accounting guidance for leases be reconsidered. Since then, FASB and the IASB have been working to come up with a standard that would address criticism that accounting for lease transactions does not represent the economics of all leases, in part because most of them are not reflected on the balance sheet.
“The definition of a lease is far better,” FASB member Tom Linsmeier said of FASB’s standard. “I also think putting on the balance sheet leases as assets and liabilities is a great improvement in terms of faithful representation of the economics of a company.”
FASB’s classification and measurement standard for financial instruments began as a convergence project with the IASB, which published its final version of IFRS 9, Financial Instruments, in July 2014 after the boards split on certain topics.
The narrow 4–3 FASB vote to move forward reflected dissenting opinions that the project did not make substantial improvements.
“I recognise that the ultimate improvement here is not as much as some board members and stakeholders would have originally preferred,” said FASB Chairman Russell Golden. “But I do think that, based on all the input we’ve received, this is a sufficient improvement to move forward.”
Golden said he expects issuance of the classification and measurement standard by the end of the year.
—Ken Tysiac (firstname.lastname@example.org) is a CGMA Magazine editorial director.