IASB and FASB Show their Cards on Leases

The IASB FASB have begun the public discussion process on lease accounting. They published a joint discussion paper setting put preliminary views for comment, today, march 20.

Leases: Preliminary Views represents preliminary views on the subject in response to concerns raised over many years by investors and other financial statement users over lease treatment in financial statements under IFRS and US GAAP.

Leasing volumes are beginning to approach a trillion dollar U.S. dollars a year. It’s likely that a majority of those lease contracts do not appear on company balance sheets. Capital leases (also called finance leases) are recorded on balance sheets. GAAP rules set out bright lines that allow lessees and lessors to arrange lease contract terms to keep leases off-balance sheet as operating leases. Operating leases only recognize payments as expenses over the lease term.

Critics of the current regime say that:

• All leases give rise to assets and liabilities that should be recognized in financial statements. Users such as debt rating agencies and analysts adjust the reported amounts on balance sheets to roughly approximate the amount of debt that a company would have if operating leases were classified as capital leases.
• Capital leases and operating leases can result in nearly identical transactions being accounted for very differently, reducing comparability between companies.
• Bright lines let lessees and lessors manipulate lease terms to obtain an accounting result, rather than having the substance of the transaction drive the accounting treatment.

The discussion paper advocates a new approach to lease accounting. Lease accounting should be based on the principle that all leases give rise to liabilities for future rental payments and assets that should be recognized in an entity’s balance sheet. This approach is aimed at ensuring that leases are accounted for consistently across sectors and industries.

This is not a change that can be planned for in detail at this time, since the method of transition and effective dates are not known. Those issues will be discussed after comments are received on this discussion paper, and re-exposed.

The discussion paper Leases: Preliminary Views is open for comment until July 17, 2009 and can be found here: FASB site or IASB site.