IASB and FASB propose to overhaul lease accounting

New York - The International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) today published a joint Exposure Draft (ED) on lease accounting.The ED, if finalized, would represent a fundamental change in how lessees and lessors account for their leasing transactions.

Operating leases may soon be a thing of the past. The ED would require lessees to book assets and liabilities for all leases; off-balance-sheet accounting would no longer be allowed. Lessors would also be affected, with the introduction of two new models that differ from today’s accounting. The ED would require significant judgments around developing estimates of renewal periods and contingent rentals. Lessors and lessees would need to provide extensive financial statement disclosures.

“As leasing is such a common transaction, this proposal would, no doubt, affect companies around the globe and across all industries,” said Joel Osnoss, Global IFRS Leader, Clients & Markets, Deloitte Touche Tohmatsu Limited. “Many of the proposed requirements could prove time-consuming to adopt, which makes a well-thought-out work plan critical to a smooth transition to the new accounting rules. Companies that use leasing should start thinking today about how this proposal could affect their financial statements, and should consider the need to make changes to lease structuring, performance metrics, debt covenants, and systems. Education of key stakeholders will also be necessary.”

The purpose of the proposed changes to lease accounting stems from the IASB and FASB wanting to increase transparency and bring consistency to lease accounting by eliminating the differences in treatment of lease contracts under International Financial Reporting Standards (IFRS) and U.S. generally accepted accounting principles (U.S. GAAP).

“Today’s publication is a long overdue reality check, which will mean greater accounting transparency for listed companies,” Veronica Poole, Global IFRS Leader, Technical, at Deloitte Touche Tohmatsu Limited. “The downside to the standards, if implemented, will be significantly increased liabilities on the typical corporate balance sheet, which could have a knock-on effect on key performance indicators. The result could be lower asset turnover ratios, lower return on capital, and an increase in debt-to-equity ratios, which could affect borrowing capacity or compliance with loan covenants.”

The IASB has stated that the comment period will end on 15 December 2010, with the final standard due for publication in June 2011. The effective date of the new leasing standard is still uncertain. The proposed transition requirements would not grandfather any existing leases. Therefore, lessors and lessees that enter into longer-term leases will need to consider the potential affect of the proposed rules on existing leases.
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