FASB, IASB Strike Compromise on Lease Expenses

WASHINGTON, DC—The US Financial Accounting Standards Board and the International Accounting Standards Board have resolved a key sticking point as they work to establish a converged standard for lease accounting: how to account for lease expenses. Earlier this month, the boards opted for a two-method strategy depending on the type of lease—i.e. whether the lease involves the transfer of ownership rights or transfer of right-of-use.

In the right-of-use approach, which is now called Approach 1, explains Bill Bosco, a consultant for the locally based Equipment Leasing and Finance Association, the lease is capitalized and the asset is amortized straight-line and interest is imputed on the liability. The result is a front-ended expense pattern. A lease in which ownership is transferred, typically an equipment lease, will use the Whole Contract, or Approach 2, methodology. In that scenario, the asset and liability are capitalized, then adjusted monthly to equal the remaining payments.

Under this compromise approach, Bosco explains, lessees will capitalize all leases except for short-term leases, which can use the operating lease method and remain off-balance sheet. The lessee will record rent expense as under the current operating lease GAAP, which produces a straight-line cost pattern.

Lessors will use current operating lease accounting if the lease term is not for the major part of the economic life of the underlying asset, or the present value of the fixed lease payments equals substantially all of the fair value of the underlying asset. In other cases—generally applying only to leases of an entire building or land—the lessor will use the Receivable and Residual method. The same rules will not apply to equipment leases since lessees will get straight-line rent expense if the lease term for a portion of the economic life of the underlying asset, or the present value of the fixed lease payments, is insignificant relative to the value of the underlying asset.

The irony, observers say, is that this dual approach is much like the current GAAP method. "All that is likely to change is that real estate lessees will capitalize the former operating leases," Bosco, who is also principal of Leasing 101, tells Real Estate Forum. "It's great news."

However, Mindy Berman, managing director with Jones Lang LaSalle, points out that "This isn't over yet." All the boards did, she says, was overcome a longstanding sticking point with this decision. They still must write the rule and reexpose the draft. "We don't know what the end result will be yet."