Attestation Update – A&A for CPAs

Technical stuff for CPAs providing attestation services

Exposure draft on Leases – Topic 840

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I have a separate introductory comment on the FASB exposure draft.  This more technical post is for the accountants in the audience.

The FASB’s Proposed Accounting Standards Update—Leases (Topic 840)  will completely revise the accounting for leases.  FAS #13 and all its amendments will be replaced.  The FASB perceives that all leases produce a right-to-use resource that should be reflected as an asset with an offsetting liability.  The draft says the FASB believes that the current approach of keeping a lot of leases off the books has a low level of representational faithfulness to the underlying economic transactions.  In short, that means they think FAS #13 does not properly reflect the real substance of leases.

Accounting for leasors will be completely revised.  This blog will not go into detail on that since my audience will not likely be leasing out equipment or property.  Just be forewarned, the accounting and terminology will change dramatically.

Under the draft, leasees will recognize an asset reflecting the value of the right-to-use asset with an offsetting liability.  The calculation will be based on new definition of the lease term, use the incremental borrowing rate, using the ‘expected outcome’ of the lease payments.

Term – Gone is the minimum noncancellable lease term we have used in the past.  Probability techniques will be used if there are lease options or early termination options.  The lease term will be the longest lease term that is more-likely-than-not to occur.  This considers all lease options.  You may recognize this technique from the more-likely-than-not calculations for uncertain tax positions.  The organization assigns a probability to each possible term, then starting from the longest term works back until there is a more than 50% probability of having that term.

Discount rate – The organization’s incremental borrowing rate is used unless the lessor’s actual discount rate is known.

Payment amount – Use of the minimum noncancellable payment is out.  Instead, the ‘expected outcome’ is used to determine the payment amount used for the calculation.  In a break from current accounting, all future payment changes are considered.  If the lease calls for increases based on some future index, such as a CPI indicator, then the organization needs to make an estimate of the amount of the future increases and include that in the calculation.  If there are variable options, such as contingency payments, then the various options need to be probability weighted to determine the payment stream.  Yes, this is going to be a lot more work.

Amortization – the right-to-use asset is amortized straight line and the liability is amortized on the interest method.

Revisions – the lease calculations are updated when there are substantial changes.  For example, exercising a renewal option would change the probability assessments of the expected life.  A variation between the actual CPI and the estimated amount would be another example of a change that would require revising the asset and liability amounts.

Effective date – the draft does not specify an effective date.  Since the comment deadline is December 2010, it looks to me like the effective date is a couple of years away.

Editorial comment – Will the draft be implemented?  The opening sentence in the introduction to the draft says “leasing is an important source of finance.”  In the same paragraph, the draft says current accounting rules “..do not provide a faithful representation of leasing transactions.”  I don’t have much experience reading the FASB tea leaves, but those comments tell me that the FASB has decided that FAS #13 has to go and this is what will replace those rules.  Timing for effective date?  Still a couple of years away.  Impact?  A lot of leases will have to be brought onto the statement of financial position.  A lot of them.  That will take a lot of time.

Comments are due by December 15, 2010, if you are so inclined to speak up on the issue.  I browsed a few of the comments at the FASB web site.  You might say that the first few comments are somewhat critical.

Written by Jim Ulvog

September 27, 2010, 7:16 am at 7:16 am

Posted in Accounting

One Response

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  1. […] The previous proposal would have required every lease to be recorded in the same way that capital leases are currently recorded – book an asset and liability equal to the present value of payments.  In addition renewal terms would have had to be included in the calculation for any extensions that are “more likely than not” to be exercised.  See my previous discussions here and here. […]


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