The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) are proposing changes to the accounting for leases. The proposal aims to improve the quality and comparability of financial reporting by providing greater transparency about leverage, the assets an organisation uses in its operations and the risks to which it is exposed from entering into leasing transactions.
Leasing is an important activity for many organizations. Under existing accounting standards, a majority of leases are not reported on a lessee’s balance sheet. The amounts involved can be substantial. Additionally, the existing accounting models for leases require lessees and lessors to classify their leases as either finance leases (for example, a lease of equipment for nearly all of its economic life) or operating leases (for example, a lease of office space for 10 years) and to account for those leases differently.
For finance leases, a lessee recognises lease assets and liabilities on the balance sheet. For operating leases, a lessee does not recognise lease assets or liabilities on the balance sheet. The existing standards have been criticized for failing to meet the needs of users of financial statements because they do not always provide a faithful representation of leasing transactions.
In response to this criticism, in 2006 the IASB and the FASB initiated a joint project to improve the financial reporting of leasing activities under International Financial Reporting Standards (IFRSs) and US Generally Accepted Accounting Principles (U.S. GAAP).
The Boards have developed an approach to lease accounting that would require a lessee to recognise assets and liabilities for the rights and obligations created by leases.
A lessee would recognize assets and liabilities for leases of more than 12 months.
Stakeholders have informed the Boards that there are a wide variety of lease transactions with different economics. To better reflect those differing economics, the revised Exposure Draft proposes a dual approach to the recognition, measurement and presentation of expenses and cash flows arising from a lease. For most real estate leases, a lessee would report a straight-line lease expense in its income statement.
For most other leases, such as equipment or vehicles, a lessee would report amortisation of the asset separately from interest on the lease liability. The Boards are also proposing disclosures that should enable investors and other users of financial statements to understand the amount, timing, and uncertainty of cash flows arising from leases.
The leases project is a converged effort between the FASB and the IASB. The revised Exposure Drafts for both organizations are nearly identical. The differences between the two proposals are primarily related to existing differences between U.S. GAAP and IFRS and decisions the FASB made related to nonpublic entities.
The Boards are also proposing changes to how equipment and vehicle lessors would account for leases that are off-balance-sheet. Those changes would provide greater transparency about such lessors’ exposure to credit risk and asset risk.