Standard Setters Agree on Two Ways to Report Leases

FASB and the IASB have agreed to use two approaches to account for lease expenses on the balance sheet.
Kathy HoffelderJune 13, 2012

After months of heated debate, the Financial Accounting Standards Board and the International Accounting Standards Board today split their differences and decided to give corporate finance and accounting executives the ability to apply either of two methods to account for lease expenses on the balance sheet. The two methods out of the previous four that the standard setters agreed on were the “right of use” approach (Approach A) and the “whole contract method” (Approach D).

The two approaches differ greatly from each other but together seem to satisfy a variety of constituents as well as the boards. Approach A takes the right-of-use asset of a lease and amortizes it in what’s considered a “straight-line” fashion. Approach D lets the lessee allocate the lease payments evenly throughout the lease.

FASB and the IASB agreed previously to have leases of more than one year be recorded on the balance sheet. But the boards received a backlash from accounting firms, trade groups, and corporations concerning the best approach to use in reforming lease accounting.

Both methods faced some criticism. Approach A was blamed for front-loading lease costs. The Internal Revenue Service is said to be puzzled by whether or not there should be an interest expense recorded in Approach D, since payments are made over time.

Today’s decision at least clarifies how to account for equipment leases and real estate leases: equipment leases should fall under the right of use approach, and real estate leases should fall under the whole contract method.

In earlier discussions at the joint board meeting in London today, FASB originally opted for a two-method model and the IASB favored a one-method model, say market participants. But after a second vote, both boards agreed on the dual approaches.

Selecting a combination of both approaches will be welcomed by several market participants. “I believe it is the approach that will appeal to the greatest number of people affected by the standard,” said Dee Mirando-Gould, a former associate chief auditor with the Public Company Accounting Oversight Board and now director at MorganFranklin, a business consulting and technology solutions firm.

The two-lease model “is closer to the economics of leases in that some leases transfer ownership rights [for which the whole contract method is best], while others merely transfer a right of use,” added Bill Bosco, president of lease-accounting firm Leasing 101 and a technical consultant at the Equipment Leasing and Financing Assn.

Even with the decision, challenges still exist for firms entering into leases. “There is going to be more monitoring of leases and more resources needed for monitoring. Companies are not going to be able to throw it into the back of a filing cabinet,” said Mirando-Gould.

Auditors, she noted, will also have their hands full. “There’s a lot more they have to be worried about,” she said. Companies might have to go back in time to get their lease documents in line, which is always a challenge for auditors, she added.

FASB and the IASB will publish a joint exposure draft on the topic in the fourth quarter of 2012. Another comment period is also likely.

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