A lease is a contractual arrangement calling for the lessee (user) to pay the lessor (owner) for use of an asset for a certain time. Leasing is a common activity and agreement, which appears on the company’s financial statement all the time, no matter fortune 500 companies or startup firms. Most of the companies will rent tangible property including offices and machines is called a rental agreement. When it comes to accounting, leasing becomes one of the most important sources of the financial statement. Since 1977, Financial Accounting Standards Board (FASB) set accounting standards to regulate leases that show on the financial statement. However, current accounting rules for leases are unable to meet the needs of users of financial statements because they do not provide a truthful representation of leasing transactions (Financial Accounting Standards Board). As a result, Financial Accounting Standards Board (FASB) and International Financial Reporting Standards (IFRS) decided to create a joint project to redefine the accounting rules for leases (IFRS 1). Therefore, the draft of the new accounting standard was made in 2010 and is expected to be applied in 2013.
The FASB and IFRS have proposed various changes, which should be implemented within leasing accounting. Following resolutions made by the boards, executor costs, for example, property taxes, maintenance charges within the common area as well as operating expenses will no longer be included within the asset right-of-use. Deductions of these amounts can be done on the right-of-use leases’ carrying amounts, inclusive of gross along with complete service leases (Bragg 45). The new changes will allow sale-leaseback dealings to be incorporated within the balance sheet in the event that they satisfy the transfer of control standards featured in the fresh model of revenue recognition (Financial Accounting Standards Board). The idea of the seller continuing to make use of the property as the lessor will no longer affect the manner in which the sale is treated in accounting terms. This change is bound to bring great relief when compared to the present US GAAP (FAS 98), which dictates that every kind of non-resource financing done by sellers or shared appreciation should prohibit sale treatment despite the arrangement’s economic substance. In addition, in case the leaseback rents do not present fair value, the liabilities, losses, assets, and gains should be adjusted to make a reflection of the fair rents, which are currently in the market.
The proposed changes will also make disconnection on timing. Measurement along with right-of-use asset recognition will be reviewed. Discount rates will be formulated in the course of signing the lease, that is, during the inception period. However, liability along with assets will remain unmeasured and unrecognized within a balance sheet up to the time when the lessee undertakes possession, that is, during the commencement period (Bragg 45). During inception, the discount rates will be known. However, the other assumptions, which affect decisions concerning the lease, term, and rental escalators’ estimates along with contingent rent, will be formulated during the commencement date. This incapability to have the balance sheet locked down along with P&L implications concurrently bring about operational concerns along with difficulties in the negotiation of the lease. Within the arrangements, which are build-to-suit, the impact is specifically pronounced because an 18-24 months gap or even more exists between the inception period and the commencement period.
Besides, contrary to the present, US GAAP (EITF 97-10) the new changes will bring about build-to-suits clarity. The new proposal does not insist on having different requirements for the build-to-suit arrangements. Lease payments are done before commencement will be included in the right-of-use asset during commencement. Costs experienced by the lessees before commencement will be catered for using other available standards. This decision is set to simply arrangements greatly and permits the emergence of driven practices, which are more commercial without the fear of affecting the tenant’s ongoing constructions. After the changes are implemented, incentives offered by the lessor, for example, improvement allowances offered to the tenant will be taken as right-of-use reduction costs (Financial Accounting Standards Board).
Moreover, the board has decided to introduce the non-cancellable duration, which is, the contract period considered the minimum. Moreover, it is examining the possibility of having the lease contract period extended or terminated if there comes about essential economic incentive, which allows an entity to alter the original option. Moreover, the Boards have agreed that reassessment of the lease terms should only be undertaken during the specified scenarios. The alteration in the definition of the lease has created a room whereby the fear of the occurrence of unforeseen changes is no longer an essential assumption (Prevents 67).
Even though the majority of the inadequacies linked to the current lease guidance stem from how operating leases are treated within the lessees’ financial statements, maintaining the present lessors’ lease guidance will turn out to be conflicting with the proposed changes (IFRS 1). In addition, it will conflict with the revenue recognition proposed by the Board. Within the Leases Draft, a lease as a term has been described by the Board as a contract within which the rights of using a particular asset are specified, for a set time, in return for a certain consideration (Previts 83). Various specifications were made by the Board to explain the conditions within which the term should be utilized. In the first place, concerned entities will establish whether a contract entails a lease by evaluating whether:
- The contract fulfillment relies on the utilization of a particular asset and
- The contract outlines the right of controlling the specified asset within a certain time.
To lessen the probable burden of making use of the revised standard within the initial year of implementation, the Boards have reached a consensus that both the lessees along with lessors have the choice of applying one of the reliefs:
- It is not necessary that an entity evaluates the contract’s premier direct costs that commenced before the effectual date (Prevents 65).
- An entity has the choice of using hindsight during comparative periods of making reports in addition to when making decisions whether the contract is a lease or not a lease.
Moreover, the Boards reached the final decision that both the lessees along lessor have to offer transition disclosures, which are in line with Accounting Changes and Error Corrections Topic 250; as well as Accounting Policies, Changes in Estimates and Errors IAS 8. In accordance with these specifications, they are not supposed to disclose the change effect on income in relation to continuing operations; ultimate income, other financial statement items that are affected along with any other aspects related to present period per-share costs. In addition, in case, the entity chooses one of the proposed reliefs, disclosure of the selected reliefs should be made by the entity. The proposed changes also entail new sales along with leaseback transactions guidelines (Nikolai, Bazley, and Jefferson 76). The Board however drafted provisional decisions concerning transition sales accounting along with leaseback transactions arrived at before the commencement date. For the sales as well as leaseback deals which led to (U.S. GAAP) capital lease or even finance leases classified under IFRS, a lessee is not supposed to readjust sale recognitions that have been previously concluded and would not reevaluate lease assets along with lease liabilities recognized in the financial statement position previously (IFRS 1).
There are also other various considerations of transition. The Board agreed that the leases, which are considered short-term, did not require transition guidelines. Subleases, fairly valued property investments, purchases along with sales, which are considered as in-substance, will also not be subjected to the transitional guidelines. Matters concerning secured borrowings along with fairly measured investment properties are yet to be determined as well as finalized. Once the proposed changes are implemented, the lease contract will no longer have any sort of ambiguities (Prevents 65). Willing parties will be able to seal lease contracts without any suspicion of unfair dealings. Nevertheless, there are several voices, which have been raised in opposition to the proposed amendments. The opposing voices doubt the credibility of the proposed changes, which have been formulated after numerous re-deliberations. However, the majority of the people have collectively agreed that the proposed changes are essential for making lease accounting better. In addition, the proposed changes have received a lot of support because they propose fair lease transactions, which favor both the lessor and the lessee.
Bragg, S. M. Wiley Gaap 2012: Interpretation and Application of Generally Accepted Accounting Principles. Hoboken, NJ: John Wiley & Sons Inc, 2011. Print.
Financial Accounting Standards Board. “Leases—Joint Project of the FASB and the IASB.” IFRS. 2011. Web.
IFRS. “Leases.” IFRS. 2011. Web.
Nikolai, L. A., Bazley, J.D., and Jefferson P. J. Intermediate Accounting. Australia: South-Western/Cengage Learning, 2010. Print.
Previts, G. Research in Accounting Regulation: A Research Annual. Amsterdam: Elsevier, 2008. Print.