On May 16, 2013, the FASB issued Proposed Accounting Standards Update (ASU), Leases. In our last post (LINK), we covered how this ASU creates a new definition of a lease with Type A and Type B leases. Read on to learn more about the accounting implications of this ASU.
The proposed ASU requires a lessee to recognize an asset and liability for any lease that has a maximum possible term of more than 12 months. The right to use the equipment or property is recognized as an asset, and the obligation to make lease payments is recognized as a liability. The asset and liability are initially measured at the present value of the lease payments.
After initial recognition, lessee accounting differs depending on whether the lease is a Type A lease or a Type B lease. For Type A leases, the discount on the lease liability is recognized as interest expense, and the right-of-use asset is separately amortized. Type A leases are essentially accounted for as financing transactions where expenses are front-loaded. For Type B leases, a single periodic cost is recognized, which combines the discount on the lease liability with the amortization of the right-of-use asset. This expense is recognized on the straight-line basis.
Lessors account for Type A and Type B leases differently at commencement of the lease and in subsequent periods. The main difference is the potential derecognition by the lessor of Type A leases, where for Type B leases the lessor continues to recognize the asset.
For Type A leases, the lessor moves the equipment or property off of the balance sheet and replaces it with an asset that includes the right to receive payments from the customer and the residual right to the asset at the end of the contract, which is the right the lessor retains in the underlying asset. The lessor recognizes any profit from derecognizing the leased asset at the lease commencement date. As it receives the lease payments, the lessor recognizes a discount on both the lease receivable and the residual as interest income.
A lessor accounts for Type B leases in a manner similar to that for the current accounting for operating leases. That is, the lessor continues to recognize the underlying asset and recognizes lease income over the lease term typically on a straight-line basis.
The lessee and lessor disclosure requirements proposed are more extensive than current lessee and lessor disclosure requirements. Both are generally required to disclose detailed information about all of the following in their financial statements or notes:
- Its leases.
- Significant judgments made in applying the lease accounting requirements to those leases.
- The amounts recognized in the financial statements relating to those leases.
In addition, if applicable, the following disclosures must also be made:
- Disclosures required for related-party leases.
- Disclosures required for sale and leaseback transactions.
The proposed guidance may have significant implications on business plans and overall strategies, buy vs. lease decisions, financing arrangements and covenant calculations, contract negotiations, and virtually any other area that is affected by financial condition or results of operations.
The boards plan to make a final decision on the proposed rules for lease accounting during the first quarter of 2014. Implementation timelines and guidance would be provided at that time.