FASB proposes lease accounting changes

Image by Getty Images via Daylife

The FASB has released a Discussion Paper and Snaphot summary to solicit comments on sweeping changes to the accounting of leases.

"According to the World Leasing Yearbook 2009, in 2007 the annual volume of leases amounted to US$760 billion. However, the assets and liabilities arising from many of those contracts cannot be found in entities’ balance sheets. "

This is because leases are splits leases into two categories: capital leases and operating leases. If a lease is classified as a capital lease, assets and liabilities are recognised in its statement of financial position. For an operating lease, the lessee simply recognises lease payments as an expense over the lease term.

Per the Snapshot, if this principal is adopted, the lessee would be required to account for:

• an asset - for its right to use the leased item (the right-of-use asset)
• a liability - for its obligation to pay rentals.

"The boards think that ensuring that all leases are depicted on the statement of financial position would significantly increase the transparency and the comparability of lease accounting."

What about renewal options and other lease rights? The FASB proposes that lessees do not "have to recognise renewal, termination or purchase options separately. Instead the lessee would determine whether the option will be exercised."

That seems pretty straightforward, but there are some significant implications.

Take, for example, a tenant with a five-year lease with a renewal right thereafter of an additional five-year term. The tenant would not be required to recognize the renewal option as a separate asset. "Instead, the lessee would determine the most likely outcome—will the lessee exercise its option or not? If exercising the option is the most likely outcome, the lessee would recognise a right to use the real estate for 10 years and an obligation to pay 10 years of rentals."

However, let's be honest. An existing tenant is at a disadvantage in any negotiation because the landlord knows that there are considerable costs involved with a tenant's decision to move its operations. Generally, a tenant's only way to counter this and regain any leverage is if the landlord belives they will actually move.

If that tenant's financials are available on public record, does the tenant's bargaining position diminish if the landlrod knows that the tenant is telling its investors that it is so likely to stay, that it is willing to take a liability on its books? This is one to watch.

Related articles by Zemanta

• FASB proposes lease accounting changes (lawfirmpracticegroup.blogspot.com)
• Reduce Your Rent with This Simple Letter (lifehacker.com)