Accounting & Auditing

At a joint meeting last week, the Financial Accounting Standards Board and International Accounting Standards Board tentatively agreed to reissue the exposure draft on leases before the end of 2011. The boards originally issued the exposure draft in August 2010, generating significant comments from the public and investors.

Significant changes to the original exposure draft include lessor accounting, lease payments dependent on an index or rate and disclosures in lessee financial statements.

Lessor Accounting

Current generally accepted accounting principles require the lessor to evaluate if the lease falls into the sales, direct financing, leveraged or operating category. In the revised exposure draft, lessors have only one option:  the “receivable and residual” approach, similar to the “derecognition approach” discussed in the first exposure draft. At the commencement of a lease, the lessor will recognize a right to receive lease payments—the sum of the present value of the payments—and a residual asset. The residual asset is initially measured as an allocation of the underlying asset’s carrying amount. The lessor will recognize profit on the leased asset at the commencement of the lease if it is “reasonably assured.” This profit will be the difference between the lease payment receivable and the carrying amount of the underlying asset.

This approach could create complex calculations in multitenant commercial and retail lease situations.

Variable Lease Payments

Leases containing variable lease payments based on an index or a rate have been a source of confusion for both lessors and lessees in the calculation of the present value of the future lease payments. For the revised draft, the boards tentatively decided leases with an index or rate should initially be measured using the index or rate existing at the commencement of the lease. This means potential future lease payment changes based on an index will not include expected rate changes in the initial calculations of present lease payment value. Lease payments dependent on an index or rate will be reviewed at the end of each reporting period after commencement of the lease. If changes are made in carrying values, lessees will account for these changes in profit and loss if they relate to current or past periods and as an adjustment to the right-to-use asset if they relate to future periods.

Lessee Presentation & Disclosure

In the revised exposure draft, the boards tentatively agreed to several items related to presentation and disclosure for lessees. The changes should increase the transparency of leasing transactions into which the entity has entered. Much of what was tentatively agreed to is similar to the original exposure draft, with some additional clarification.

The boards are expected to release the revised exposure draft before the end of 2011, with a final standard some time during mid-2012. To learn more about how the proposed standards could affect your organization, contact your BKD advisor.