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FASB and IASB Agree on Lease Accounting

June 18, 2012

The FASB and IASB agreed last week to a lease accounting model in which all leases with a term of one year or more would be recorded on the balance sheet. The decision will increase both sides of company balance sheet by recording a lease liability that represents the current value of the lease’s non-contingent payments and a corresponding right-of-use asset.

This is a significant change from current practice where leases that are classified as operating are maintained off-balance sheet. The decision has the potential to significantly affect debt covenant ratios and introduce timing differences to the recognition of certain leasing expenses.

FASB and the IASB’s agreement comes almost two years after they issued an initial exposure draft that proposed capitalizing all leases. Complex calculations and estimates that the original exposure draft required are expected to be eliminated in a new joint exposure draft the boards scheduled to issue by the end of the year.

The boards previously agreed that leases should be recorded on the balance sheet, but have continued to discuss the classification and pattern of expenses in the income statement. In the recent decision the boards decided upon an approach in which some lease contracts would be accounted for using an approach similar to that proposed in the 2010 Leases exposure draft and some leases would be accounted for using an approach that results in a straight-line lease expense.

“The boards have reached agreement on a proposed approach to put leases over one year on the balance sheet. We will publish our proposals for public comment, with a view to completing this important convergence project during 2013”. stated Hans Hoogervorst, Chairman of the IASB. Leslie Siedman, Chairman of the FASB, comments that “The boards carefully considered the diverse views of stakeholders about whether the income statement profile of all leases should be the same. On balance, we decided that leases that convey a relatively small percentage of the life or value of the leased asset should be recognised evenly over the lease term”.

Companies should analyze the potential impact of the new proposal to determine what impact it will have have on debt covenants agreements and other liquidity and capitalization requirements. Doing so will allow time to plan for and resolve any issues identified thereby minimizing the potentially negative impact of a new lease accounting model.

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