On May 16, 2013, the FASB issued Proposed Accounting Standards Update (ASU), Leases. This proposed ASU is a complete rewrite of the lease accounting rules that have been in effect since 1976. Under existing accounting standards, a majority of leases are not reported on the lessee’s balance sheet, and the amounts involved can be substantial. The new requirements, if approved, would put leases on company balance sheets and give analysts and investors a better idea of a company’s liabilities and expenses.
The new definition of a lease
Under the proposed ASU, a lease would be defined as “a contract that conveys the right to use an asset . . . for a period of time in exchange for consideration.” In addition, the proposed ASU requires companies to determine if contracts not labeled as leases should be accounted for as leases by assessing whether contract fulfillment requires the use of an identified asset, or whether the contract conveys the right to control use of an identified asset for a period of time in exchange for consideration.
There will be two types of leases (A & B)
The proposed ASU differentiates between Type A and Type B leases. Type A leases are leases involving assets other than property, such as equipment, aircraft, trucks, and cars. These are leases where the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset. In addition, a lease is Type A if the lessee has a significant economic incentive to exercise an option to purchase the underlying asset. Type B leases are all other leases, primarily property leases. Property includes land, a building, a part of a building, or both land and a building.
A lease of other than property can be a Type B lease (rather than a Type A lease) if the lease term is for an insignificant part of the total economic life of the underlying asset, or if the present value of the lease payments is insignificant relative to the fair value of the underlying asset at the commencement date.
Conversely, a lease of property can be a Type A lease (rather than a Type B lease) if the lease term is for the major part of the remaining economic life of the underlying asset, or if the present value of the lease payments accounts for substantially all of the fair value of the underlying asset at the commencement date.
In our next installment, we’ll cover lessee accounting, lessor accounting, disclosures and how these rules may affect you.