Recent Changes of the Lease

Introduction

Lease transactions have become popular over the years due to the reason that businesses have been transforming and in the process, they have been seeking new ways of financing long-term assets. For a long time, leasing has offered an attractive advantage of 100 percent financing that has included off-the-books obligations (Epstein, Nach, and Bragg 792). Giving the estimates for the year 2005, the Securities and Exchange Commission noted that there were approximately $ 1.3 trillion of off-balance-sheet obligations outstanding for all the public companies (Epstein, Nach and Bragg 792).

But as from 2009, FASB embarked on a process of reexamination of lease accounting, and together with an international standard-setting body, IASB, they were convinced that all leases should be reported on the statement of financial position as capital leases and that there was the need to standardize accounting procedures of leases; and in the same measure, promote uniform comparison of financial statements (Richardson, Snyder and Wisniewski Para. 1).

The purpose for the changes in lease accounting rules

Working jointly, the FASB and IASB in 2006 established a Memorandum of Understanding that was to see the two boards work together towards the process of converging accounting standards (Shea Para. 2). The conviction had arisen from the fact that leasing accounting had demonstrated controversies especially with regards to ‘off-balance-sheet’ treatment of operating leases and the criteria had been described by many to be subjective to manipulation, in addition to being an opportunity that had been exploited by lease accountants with intentions of mitigating the effects of lease capitalization (Epstein, Nach and Bragg 866).

At the same time, many have criticized the current lease accounting models claiming that they exhibit many differences, for instance, the capital and operating models use different approaches which in turn result in inconsistency (Kuczborski Para. 2). Richardson, Snyder, and Wisniewski (Para. 3) on the other hand state that the different accounting treatments of capital and operating leases have brought about numerous concerns from users of financial statements and also the investors.

Another observation was that the current lease accounting had failed to recognize a contractual liability and the related process of acquiring assets. McConnell (Para. 3) noted that under the current operating lease accounting there was no recording of assets or liabilities, while under that of finance lease accounting, it was only the contractual lease payments accrued under the initial lease agreement which qualified to be included in the records of assets and liabilities. As a result, there is always under-recording of assets and liabilities, thus a new rule was seen as appropriate in addressing this.

Other issues that have necessitated the need for changes in lease accounting rules in the recent past have been: 1) operating lease disclosures have not been able to provide the users of financial statements with enough information to evaluate and ascertain the totality of related assets and liabilities, 2) the current lease accounting rules have been viewed by some users to be too complicated because many lease transactions in most instances are multi-faced and the overall results sometimes have been inconsistency in capitalization (William Para. 4), 3) lastly, the current lease accounting rules have provided less information that sometimes has resulted in misinformation and under-information by various financial users.

The recent change of the lease

As a result of the project undertaken by FASB in addressing the concerns raised by numerous financial statement users, major changes have been proposed. Lessees are mandated to regard and treat all leases as capital leases and will be able to use a method known as the ‘right to use the method’ which has been proposed by the board. In the views of the board, the right to make use of leased assets should be regarded to be an asset, and the responsibility to make payments for the lease should be seen to be a liability.

To these views, the board suggested that the asset and liability need to be recorded at the lessee’s cost and in determining the cost of the leased asset, a calculation of the present value of the payments made for the lease that in turn will be discounted by using the lessee’s rate of increased borrowing should be adopted (Shea Para. 8).

McConnell (Para. 1), writing on the new changes, explained that the changes were to see the elimination of the operating lease accounting and this, in turn, was to result in improvements in the financial reporting by lessees. The author’s proposal for changes was that all leases, without emphasizing their terms, should be accounted for in a way that resembles finance leases accounting. McConnell further noted that under the new changes, all cash payments due from the lease should be included in the amounts regarded as ‘capitalized’ and the amounts are to include, “contractual amounts due over the lease term as well the lessee’s best estimate of contingent rents due over that period” (McConnell Para. 2).

The new changes also instituted the need for the lessee to make a reassessment of the terms of the lease, rentals about contingent, guarantees that are attached to the residual value, and lastly, obligations that appertain to the lease at every date of reporting (Anonymous Para. 4). The conviction of the board is that through such initiatives and undertakings, adequate and useful information will be provided to the financial statement users. What should be realized is the fact that most of these changes remain as proposals and their application is anticipated to occur as from 2011.

Rules guiding lease accounting in the recent

Many of the rules that have been used in lease accounting until recently were formulated in 1976 by the Accounting Standards Board (FASB), with the first issue of the rules being known as Financial Accounting Standard No. 13 (FAS 13). However, although the standard has changed over time, its basic rules have stayed fairly constant. The FAS 13 postulates that the closed-end lease should be reported by lessees in the same manner office lease are recorded. Further, lease payment is recorded as an expense each month and no asset or liability should be set up on the lessee’s balance sheet even if a contracted obligation may be in existence.

Moreover, the FAS 13 rules allow lessors to design leases in a way that resembles modified open-end leases, which provide the lessor with the protection of a usual open-end lease while allowing the lessee the off-balance sheet treatment. This capability to alter a contract to manipulate the accounting rules is what has constituted the big issue and clamor for changes in the lease accounting, which have preoccupied the FASB and IASB boards.

Conclusion

The concerted effort by the FASB and IASB cannot be disputed or challenged. Changes in lease accounting are inevitable and timely, and changes that are propagated by globalization cannot afford countries to remain with the same lease accounting rules and techniques. However, of importance is the need for the boards to address the questions being raised that regards the implications to be witnessed as a result of implementing the lease accounting changes. Moreover, there is a need for FASB and IASB to bring all the stakeholders on board to ensure the changes proposed to have less impact on all financial players and other interest parties.

Works Cited

Anonymous. “Lease accounting: there could be blood all over the streets!” PriceWater HouseCoopers. 2009. Web.

Epstein, Barry J., Nach, Ralph and Bragg, Steven M. Wiley GAAP 2010: Interpretation and Application of Generally Accepted Accounting Principles. NJ, John Wiley and Sons. 2009. Web.

Kuczborski, Michael. D. “Major Lease Accounting Changes on the Way.” Major Lease Accounting Changes on the Way. 2010. Web.

McConnell, Patricia. “Patricia McConnell: Will the elimination of the operating lease accounting improves financial reporting by lessees?” Patricia McConnell: Will the elimination of the operating lease accounting improve financial reporting by lessees? 2010. Web.

Richardson, Pierce, Snyder, Henry W. and Wisniewski, Derek M. “Proposed lease accounting change may significantly alter the financial statements of lessees.” Tax and Real Estate Investment, Finance, and Development Alert. Delaware. 2009. Web.

Shea, Timothy H. United States: Looming Lease Accounting Rule Changes: Impact on Earnings, Debt Covenants, Compensation Arrangements, and Earnout Agreements. 2009. Web.

William, Bosco. “Lease accounting: are current rules as bad as some say?” Financial Executive Publication. 2006. Web.