The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) recently agreed on accounting approaches for lease expenses as part of a project to revise International Financial Reporting Standards and the U.S. Generally Accepted Accounting Principles (GAAP). The boards had addressed long-standing concerns that lease obligations are often not recorded on the balance sheet and that the current accounting methods do not properly represent all lease transactions.
Background: Since 2010 when the IASB and the FASB initially published an exposure draft on lease accounting, the two boards have been trying to reach agreement on how to account for equipment and rental leases on the balance sheet. For years, these leases had remained off the balance sheet and were usually found in the footnotes of company financials.
Most industry participants have accepted the need to record leases on the balance sheet and exempt short-dated leases of less than 12 months from the accounting standards. However, this is not true when accounting for leased equipment.
The joint proposal changes the way equipment leases are treated in the Profit and Loss Statement. Under Approach 1, companies that lease equipment would now have to take into account interest and depreciation expenses. As a result, they would have to provide higher interest charges at the beginning of a lease and lower charges at the end of the lease (i.e., front-loading). Currently, interest charges on equipment are typically consistent throughout the term of the lease. This could have a significant impact on both lessees and lessors.
In addition, the boards proposed Approach 2, a methodology for treating the rental payment in a company’s cash-flow statement. This plan, which uses a straight-line method of accounting, recognizes a single lease expense over the entire life of the lease. The approach amortizes the rent expense in the income statement.
Final point: Be aware that the decisions reached by the two boards are preliminary. A revised exposure draft is expected by the fourth quarter of this year although most experts expect few changes.