Spotlight on Lease Accounting Disclosures
In January, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) met to discuss the proposed accounting standards for businesses that lease assets. As usual, the two rulemaking bodies largely “agreed to disagree” about how companies should disclose the more complex lease obligations in their footnotes. Here’s a closer look at the latest developments on the lease proposal, which remains a work in progress after more than a decade of joint collaboration.
Revising lease accounting
For years, investors and analysts have criticized the existing accounting rules that permitted many companies — including airlines, retail chains, real estate ventures and manufacturers — to keep lease expenses off their balance sheets and hide massive liabilities. FASB and the IASB started the long-running lease convergence project to make businesses around the globe report the expenses they have tied up in commitments to rent office space, warehouses, equipment and vehicles.
After years of meetings and numerous staff research projects, the boards still haven’t been able to come to a consensus on how to account for leases. They agree that lease obligations of more than 12 months should appear as liabilities on the balance sheet. But they disagree about how to report lease expenses on the income statement.
In 2013, FASB and the IASB issued the latest, mostly converged, proposals on how to report long-term lease contracts. But these proposals have been met by significant opposition, especially from U.S. businesses that don’t want to alter established reporting practices or report more debt to stakeholders.
Rather than continue to debate how to report lease expenses, the boards have shifted their attention to footnote disclosures for lease obligations. Businesses have criticized the disclosure requirements in FASB’s Proposed Accounting Standards Update (ASU) No. 2013-270, Leases (Topic 842), and the IASB’s Exposure Draft (ED) No. 2013-6, Leases, as being overly detailed and complex. On the other hand, investors want more insight into the types of rental arrangements businesses engage in to get a better picture of their overall financial obligations.
During the January meeting, the boards made some headway. Overall, they decided to retain the lease disclosure objective: “Enable investors to understand the amount, timing and uncertainty of cash flows arising from leases.” They also agreed to require companies to disclose information about various lease expenses and recommended (but did not require) the use of an investor-friendly tabular format that would include such information as:
- Short-term lease expense,
- Variable lease expense,
- Sublease expense,
- Cash paid for amounts included in the measurement of lease liabilities,
- Supplemental noncash information on leased assets,
- Weighted-average remaining lease term, and
- Gains and losses on sale and leaseback transactions.
In addition, the boards eliminated the requirement to disclose the reconciliations of opening and closing balances of lease liabilities and assets.
But that’s where the agreement ended. FASB voted to proceed with its proposed requirement to disclose a maturity analysis of lease liabilities, while the IASB decided to give businesses more leeway in determining whether to comply with the maturity analysis requirements.
For businesses with more complex, unusual or otherwise significant lease arrangements, the IASB is recommending business-specific disclosures. This may include information about variable lease payment terms, extension options and termination clauses, residual value guarantees and sale and leaseback transactions.
Looking to the future
After two formal proposals each and complaints from various stakeholders, FASB and the IASB haven’t been able to agree on how companies should account for leases on their financial statements. The boards now say their goal is to minimize the differences between U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards, rather than produce identical accounting standards.
In a recent interview, FASB chairman Russell Golden reassured U.S. companies that the board would consider the impact that the lease standard would have on debt covenants and provide examples related to the definition of a lease. The boards plan to publish final standards sometime this year, but no official implementation date has been set.
Achieving consensus on how to report leases on the balance sheet is fairly straightforward. But FASB and the IASB are at odds when it comes to reporting lease expenses on the income statement.
The IASB wants all lease expenses to be treated as financing transactions, meaning interest and amortization would be calculated with rent expense. Because interest is calculated on a declining balance over time, the cost to rent a piece of equipment would look more expensive at the beginning of a lease. Many U.S. companies say such accounting treatment will make them look more leveraged than they are and diminish their market value and creditworthiness.
Conversely, FASB views some lease arrangements as financing transactions and others as simple rentals. Companies with rental-type contracts would report payments evenly over time. Businesses would decide how to account for their leases based on what the IASB believes is an arbitrary dividing line that will make the accounting more complex, which is counter to one of the project’s goals — to simplify financial reporting.
In a recent interview, FASB chairman Russell Golden agreed that investors would benefit from adjusting the balance sheet presentation of leases. But he doesn’t plan to change how leases are reported on the income statement, because it would be costly to implement and provide limited value to stakeholders.
Stay tuned for the latest developments on accounting standards for businesses that lease assets. If you have questions, please contact Dan Ward, Manager, Audit Services, at 314.983.1237 or firstname.lastname@example.org.