Academic journal article Review of Business

Lease Accounting Change: It's Not over Yet

Academic journal article Review of Business

Lease Accounting Change: It's Not over Yet

Article excerpt

Executive Summary

The FASB and IASB initiated a joint project to revise leasing rules in 2006, and eight years later in 2014 are getting closer to a revised leasing standard, although challenges to a single approach remain. The objective of the parties is to transparently represent the economic substance of a leasing transaction on the financial statements to investors, without creating undue cost and complexity for preparers of financial statements.

The inherent nature of leasing is highly complex, defying simple solutions. However, the parties are getting closer to their objective. Under the approach most likely to be adopted, the majority of equipment and real estate leases would be recorded on balance sheet and require capitalization treatment. Small ticket and short-term leases will receive consideration separately from standard leases for lessees, and serious debate remains whether lessor accounting should be affected at all because it presently meets user needs.


Many U.S. companies use leasing as a means to obtain property or equipment without expending a large initial cash outlay, while also maintaining a certain level of flexibility and avoiding the risk of asset obsolescence. Leases allow the lessee company the right of use (ROU) to an asset for a period of time in exchange for periodic payments. For one class of lease, neither the liability for future rent payments nor the leased asset appears on the lessee's balance sheet.

Back in 2005, the Securities and Exchange Commission (SEC) issued a report on off balance sheet accounting and recommended that the Financial Accounting Standards Board (FASB) specifically address lease accounting as it allows companies to keep assets and liabilities "off balance sheet" and does not represent the economic substance of the transaction. (1)

Further, the off-balance sheet treatment of certain leases reduce the transparency and comparability between companies, as investors and others do not have an effective means of comparing companies with leased assets to those that purchase assets because the debt associated with the lease is buried in disclosure footnotes and requires substantial estimation and manipulation by interested users to calculate ratios that assess financial performance.

Timeline of Development of New Lease Standard

Subsequently, in 2006 the IASB and the FASB initiated a joint project to revise leasing rules. The companies most affected by the rule change are those that lease real estate and equipment for greater than twelve months.

In a recent survey by Deloitte, ninety-four percent of firms carrying leased assets would be affected by proposed changes to lease accounting rules. The change therefore has widespread impact. (2)

In March 2009, the FASB and IASB formally published and solicited comments on a discussion paper, Leases: Preliminary Views. In August 2010, the boards issued their original exposure draft, which generated more than 780 comment letters from stakeholders. Many respondents were of the view that the provisions within the original exposure draft would impose an undue burden on stakeholders while not meeting the objective to present the true economic substance of the right of use to an asset and its related contractual liability.

Preparers commented that the anticipated economic impact of the proposed change could result in violations in debt covenants by increasing debt ratios affecting financial and credit markets, and having far reaching consequences in real estate values and leasing companies.

As a result, the boards deliberated on a path forward for lease accounting and on May 16, 2013, a revised exposure draft (2013 ED) was issued by the FASB and IASB. The boards received in excess of 640 comment letters on this second proposal, almost all of which provided negative criticism of the proposal. In addition, as part of their outreach, the FASB and IASB hosted several roundtable discussions in various locations around the globe. …

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