In August 2010 the Financial Accounting Standards Board (FASB) issued an exposure draft that proposed fairly dramatic changes to U.S. generally accepted accounting principles (U.S. GAAP) governing accounting for leasing transactions. These changes embodied in the proposed standard will affect both lessors and lessees. Since more companies are involved in leasing transactions as lessees rather than as lessors, the following focuses on how the proposed standard is expected to affect lessees.
The Current Standard
In November 1976 FASB issued Statement of Financial Accounting Standards 13: Accounting for Leases (SFAS 13). Prior to the issuance of SFAS 13, all leases were accounted for as operating leases. Accordingly, lessees recorded and reported lease payments as rental expenses and neither leased assets nor lease obligations appeared on lessees' balance sheets.
SFAS 13 changed all that when it introduced the concept of the capital lease. Under SFAS 13, leases are presumed to be operating leases. If a lease meets any one of four criteria (see Exhibit 1 on page 20), it qualifies for capital lease treatment and the lessee is required to record and report the underlying assets and related lease obligations on its balance sheet.
Exhibit 1:: Capital Lease Criteria--Current GAAP
1 The lease transfers ownership of the property to the lessee by the end of the lease term.
2 The lease contains a bargain purchase option. A bargain purchase option is a "provision allowing the lessee, at his option, to purchase the leased property for a price which is sufficiently lower than the expected fair value of the property at the date the option becomes exercisable that exercise of the option appears, at the inception of the lease, to be reasonably assured."
3 The lease term is equal to 75 percent or more of the estimated economic life of the leased property.
4 The present value at the beginning of the lease term of the minimum lease payments, excluding payments representing executory costs, equals or exceeds 90 percent of the fair value of the leased property to the lessor at the inception of the lease.
The provisions of SFAS 13, as amended, constitute the current standard for leasing transactions.
The Proposed Standard
The FASB exposure draft issued in August 2010 is part of a joint 'project between the FASB and the International Accounting Standards Board (IASB). The joint project is intended to improve the financial reporting of lease contracts and facilitate the convergence of U.S. GAAP and International Financial Reporting Standards (IFRS).
The FASB and IASB received 760 comments during the four-month comment period after the respective exposure drafts were released.
The volume and nature of the comments received led the two boards to conduct outreach activities to solicit input from financial statement preparers, users and auditors. On Feb. 8, 2013, FASB issued a Project Update that announced its intent to issue a revised exposure draft later in 2013.
One of the goals of the proposed standard is to develop an approach to accounting for leasing transactions that would "ensure that assets and liabilities arising under leases are recognized in the statement of financial position." In general, the proposed standard requires lessees to record and report as an asset the right to use the underlying asset, and to record and report as a liability the obligation to make lease payments over the lease term.
In summary, the major changes included in the proposed standard are: CAPITAL VS. OPERATING LEASE TREATMENT
Under the proposed standard all leases...