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Hi! My name is Jeffrey Taylor and I am the author of two popular equipment leasing books used by equipment leasing companies all over the world. For more information please visit Books on Equipment Leasing. FASB and IASB Joint Project On Lease Accounting - Impact on FASB 13 and IASB 1712/11/09 - Project ObjectiveThe objective is to create a common standard on lease accounting to ensure that the assets and liabilities arising from lease contracts are recognized in the statement of financial position. Lessee accounting The Boards discussed: Initial and subsequent measurement of the lessee's obligation to pay rentals and right-of-use asset Leases with options. The Boards tentatively decided to specify the required accounting for a lessee's obligation to pay rentals and right-of-use asset as follows: Initial measurement of the lessee's obligation to pay rentals would be at the present value of the lease payments discounted using the lessee's incremental borrowing rate. The Boards noted that the interest rate implicit in the lease will often equal the incremental borrowing rate. Consequently, they tentatively decided that the interest rate implicit in the lease can be used if it can be readily determinable. The staff will develop a definition of the interest rate implicit in the lease that would be consistent with a right-of-use model. Subsequent measurement of the lessee's obligation to pay rentals would be at amortized cost using the effective interest method; the obligation arising in a simple lease would not be revised for any changes in the lessee's incremental borrowing rate. The Boards will consider, at a future meeting, whether the incremental borrowing rate would be reassessed when there are changes in the expected lease term. Subsequent measurement of the obligation at fair value is not permitted. Initial measurement of the lessee's right-of-use asset would be at cost, where cost is the present value of the lease payments plus any initial direct costs incurred by the lessee. The staff will assess whether the definition of initial direct costs is consistent between U.S. GAAP and IFRSs. Subsequent measurement of the lessee's right-of-use asset would be at amortized cost and would be described as amortization rather than as rental expense. The lessee's right-of-use asset would be considered for impairment by referring to existing applicable standards for impairment. A lessee preparing financial statements in accordance with IFRS would follow IASB 36, Impairment of Assets. A lessee applying U.S. GAAP would follow Topic 350, Intangibles - Goodwill and Other of the FASB Accounting Standards Codification. IFRS preparers would be permitted to revalue their right-of-use assets using the revaluation model in IASB 38, Intangible Assets; U.S. GAAP preparers would not be permitted to revalue their right-of-use assets unless required to do so to recognize an impairment loss. The Boards discussed how the lessee would account for lease contracts that grant the lessee the right to extend or terminate the lease. The Boards tentatively decided that: Uncertainty about the lease term would be addressed through recognition - that is, one of the possible lease terms is selected and the accounting is based on that term. The recognized lease term would be the longest possible lease term that is more likely than not to occur. In determining the lease term, the lessee would consider all relevant factors. Options to renew a lease that are priced at market value at the date of renewal would be considered when determining the lease term. The lease term would be reassessed at each reporting date. Detailed examination of every lease would not be required unless there is a change in facts or circumstances that indicate that the lease term may need to be revised. Any change to the obligation to pay rentals resulting from a reassessment of the lease term would be recorded as an adjustment to the right-of-use asset. Lessor accounting The Boards discussed: Initial and subsequent measurement of the lessor's receivable and performance obligation Leases with options. The Boards tentatively decided to specify the required accounting for a lessor's receivable and performance obligation as follows: Initial measurement of the lessor's receivable would be at the present value of the lease payments discounted using the interest rate implicit in the lease plus any initial direct costs incurred by the lessor. Subsequent measurement of the lessor's receivable would be at amortized cost using the effective interest method.• Initial measurement of the lessor's performance obligation would be at the transaction price (that is, the customer consideration, which will be measured at the present value of the lease payments discounted using the interest rate implicit in the lease). Subsequent measurement of the lessor's performance obligation would reflect decreases in the obligation to permit the lessee to use the leased item over the lease term. The Boards discussed how the lessor should account for lease contracts that grant the lessee the right to extend or terminate the lease. The Boards tentatively decided that: The accounting by lessors for those options would be symmetrical with the accounting by lessees for those options; however, the Boards noted that the objective of symmetry might not result in the same measurement of lease payments by the lessee and the lessor. A lessor's receivable and performance obligation should be recognized based on the lease payments that will be received over the lease term. The recognized leased term would be the longest possible lease term that is more likely than not to occur. The lease term would be reassessed at each reporting date. Detailed examination of every lease would not be required unless there is a change in facts or circumstances that would indicate that the lease term may need to be revised. Any change to the lease receivable resulting from a reassessment of the lease term would be recorded as an adjustment to the performance obligation. Timing of initial recognition The Boards decided that: Assets and liabilities arise when a contract is signed. Between contract signing and delivery, the unit of account is the contract as a whole, and the contract position would be presented net in the statement of financial position of both the lessee and the lessor. An entity would initially and subsequently measure the net contract asset or liability on a cost basis, subject to impairment. An entity would provide disclosures about the assets and liabilities that arose upon contract signing. Sale and leaseback transactions In a sale and leaseback transaction, a seller/lessee would consider whether the entire leased asset qualifies for derecognition. If the entity determines, after applying the applicable guidance for the underlying asset, that the transaction qualifies as a sale, it would derecognize the leased item and recognize a right-of-use asset and an obligation to make rental payments for the leaseback. Right-of-use approach The Boards reaffirmed the right-of-use approach for lessees which proposes that a lessee should recognize for all leases an asset representing its right to use the leased item for the lease term (the right-of-use asset) and a liability for its obligation to pay rentals. The Boards will continue discussing lessee and lessor accounting issues at future meetings. FASB 137/23/09 - FASB has received more than 150 comments letters which they must now sort through before they can finish crafting a new rule for how companies account for leases.Some companies — particularly those such as airlines, retailers, and railroad companies that will be most affected — are hoping the rule-makers will take their dear, sweet time. As it is, FASB estimates that at the earliest, a formal rule will be in place by mid-2011, 35 years after FASB 13, the current lease accounting rule, was created. The new rule will apply to all companies that lease plants, property, and equipment. Not surprisingly, such companies are not overly enthusiastic about the preliminary leanings of FASB and the IASB toward overhauling FASB 13. The rule update could move hundreds of billions of dollars in assets and obligations onto their balance sheets. Many of them are hoping they can at least convince the standard-setters that the rule doesn't have to encompass all leases. In 2005, the SEC estimated that publicly traded companies hide $1.25 trillion in future cash obligations by using operating lease treatment. 6/17/09 - FASB discussed several lessee accounting issues that were not addressed in the Discussion Paper (hyperlink follows in 3/19/09 announcement. Sale and leaseback transactions In a sale and leaseback transaction, a seller/lessee would consider whether the entire leased asset qualifies for derecognition. If the entity determines, after applying the applicable guidance for the underlying asset, that the transaction qualifies as a sale, it would derecognize the leased item and recognize a right-of-use asset and an obligation to make rental payments for the leaseback. FASB will consider whether additional criteria are needed to help entities determine whether a sale and leaseback transaction represents a sale and how to account for a sale and leaseback transaction when the sales prices or rental payments are not at market rates. Impairment of the right-of-use asset A lessee preparing financial statements in accordance with international financial reporting standards would follow the guidance in IASB 36, Impairment of Assets, to determine whether its right-of-use asset is impaired and a loss should be recognized. A lessee applying U.S. generally accepted accounting principles would follow FASB 144, Accounting for the Impairment or Disposal of Long-Lived Assets, to determine whether its right-of-use asset is impaired and a loss should be recognized. Revaluation of the right-of-use asset A lessee would subsequently report a right-of-use asset at cost adjusted for amortization and impairment losses, if any. A lessee would not be permitted to subsequently remeasure its right-of-use asset to fair value unless required to do so to recognize an impairment loss. Initial direct costs A lessee would expense any initial direct costs as incurred. Transition A lessee would apply the new lease standard by recognizing an obligation to pay rentals and a right-of-use asset for all outstanding leases at the transition date. The obligation and the asset would be measured at the present value of the lease payments, discounted using the lessee’s incremental borrowing rate on the transition date. 5/1/09 - FASB decided that a lessor would recognize an asset representing its right to receive rental payments from the lessee (a lease receivable) and a liability representing its performance obligation under the lease—that is, its obligation to permit the lessee to use one of its assets (the leased item). The lessor will satisfy that performance obligation (and will recognize revenue) over the lease term. 3/19/09 - FASB Issues Draft Proposal For Lessee Accounting Equipment leasing companies depend on the rules and regulations issued by the seven members of the Financial Accounting Standards Board (FASB) for public accounting and reporting guidelines. FASB, headquartered in Stamford, Connecticut, issued its first FASB Statement on Foreign Exchange in 1973. Since that time, FASB has issued over 150 Statements, plus a substantial amount of Technical Bulletins, Opinions, Concepts, and Interpretations. Prior to the standardization of lease accounting, equipment leasing companies could account for leases in whatever manner best benefited them. Each company did their own thing and it was virtually impossible to compare the performance of one company to the next. In 1976 FASB issued FASB 13. This historical moment began the standardization for lease accounting and reporting. Even today, there are still many different interpretations of key words contained in this famous statement. Most FASB's are first issued to the public in draft format. In conjunction with the Emerging Issues Task Force (EITF) and several public debates, FASB issues final drafts. After many years FASB's are issued with an effective date for implementation. In many cases, implementation dates are 2-3 years in the future; allowing corporations to make the necessary accounting and systems changes to comply with the new rulings. FASB 13 covers the basics for lease accounting. It sets the standards for the Financial Accounting and Reporting for Leases in the following sections:
For purposes of this Statement, a lease is defined as an agreement conferring the right to use property, plant or equipment (land and/or depreciable assets) for a stated period of time. FASB 13 states that there are two classifications of leases for lessees and four classifications of leases for lessors. For lessees, leases, which meet one or more of the criteria listed below, are called Capital Leases. All other leases are called Operating leases. For lessors, leases are either Sales-type leases, Direct Finance Leases, Leveraged Leases, or Operating Leases. In general, Sales-type leases give rise to manufacturer's or dealer's profit or loss. Normally, sales-type leases will arise when a manufacturer or dealer use leasing as a means of marketing their products. Direct Finance Leases meet the criteria listed below. Leveraged Leases are Direct Finance Leases with the addition of third party debt. All other leases are operating leases. Criteria for Classifying Leases The criteria for classifying leases derives its concept from the view that a lease which transfers substantially all of the benefits and risks incident to the ownership of property should be accounted for as the acquisition of an asset and the incurrence of an obligation by the lessee and as a sale or financing by the lessor. All other leases should be accounted for as operating leases. If at its inception a lease meets one or more of the following four criteria, the lease shall be classified as a capital lease by the lessee. Otherwise, it shall be classified as an operating lease.
Leveraged Leases meet the criteria of a Direct Finance Lease with the following additions:
Through the use of FASB 13, U.S. companies still keep off their balance sheets billions of dollars of lease obligations, only reporting the item as an obscure footnotes. For example:
Debt levels are among the most important measures of a company's financial health. But the special accounting treatment for many leases means that a big slice of corporate financing remains in the shadows. Given the choice between leasing and owning real estate or equipment, many companies pick operating leases. Besides lowering reported debt, operating leases boost returns on assets and often plump up earnings through, among other things, lower depreciation expenses. Investors complain that the 90% test drives the structuring of the deal and ignores economic reality. The accounting literature on leasing covers hundreds of pages. FASB's original 1976 pronouncement, FASB 13, does state a broad principle: A lease that transfers substantially all the benefits and risks of ownership should be accounted for as such. But in practice, critics say, FASB 13 amounts to all rules and no principles, making it easy to manipulate its strict exceptions and criteria. |
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