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Major Changes in Lease Accounting on the Horizon

Posted 11:46 AM by

Lease transactions are widely used as a financing tool in the manufacturing and distribution industries. In March 2009, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued a discussion paper regarding leases as part of the continued convergence project. The objective is to create common lease accounting requirements and to provide users of financial statements with useful and complete information with regard to leasing transactions.

Currently, a lessee accounts for a lease as either operating or capital. Under the boards' preliminary decision, a lessee would recognize an asset representing its right to use the leased asset and a liability for its obligation to pay rentals, essentially capitalizing all leases. The boards have tentatively decided the lessor would follow a performance obligation approach in which an asset would be recorded representing its right to receive rental payments and a liability representing its performance obligation under the lease.

At the inception of a lease, both the lessee and lessor would be required to estimate the ultimate term of the lease, evaluating the probability of renewal options and contingent rentals, such as increases in rents based on an index and residual value guarantees. These estimates would be periodically reassessed, which would potentially impact the recorded asset and liability. The boards have tentatively determined to include existing leases at the date of implementation, which would require companies to record an asset and liability for all outstanding leases at the date of implementation.

Balance sheets of manufacturing and distribution companies would be greatly impacted if the changes described above are implemented. Assets and liabilities would increase, resulting in increased leverage ratios.  Cash flow measures, such as EBITDA, would be impacted due to the replacement of rent expense with amortization and interest expense. These changes would also impact loan covenants and other external measures of financial performance.

The boards continue to discuss the project and are expected to issue an exposure draft by the middle of 2010 and a final accounting standard update by the middle of 2011. Implementation is expected in 2012.

To learn more and to follow the project, visit the FASB's Web site at

About the Author
Jason Patch is a partner in Katz, Sapper & Miller’s Audit and Assurance Services Group and leads the firm’s Manufacturing and Distribution Services Group. Jason works with clients to ensure accurate financial reporting, keeping an eye on their bottom line, helping them avoid risk, and maximizing efficiencies. Connect with him on LinkedIn.

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