Leases to Be Recognized on Lessee Balance Sheets

• Published date: 01 October 2016
• Date: 01 October 2016
• Author: Paul Munter,Oscar J. Holzmann
• DOI: http://doi.org/10.1002/jcaf.22196

97

© 2016 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22196

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FASB

Leases to Be Recognized on Lessee

Balance Sheets

Oscar J. Holzmann and Paul Munter

INTRODUCTION

In 2005, the SEC staff

released a study mandated

by the Sarbanes-Oxley Act1

examining the primary sources

of off-balance-sheet financing

under U.S. generally accepted

accounting principles (GAAP)

in existence at that time. The

Securities and Exchange Com-

mission (SEC) staff study

identified operating leases

as one of the top sources

of off-balance-sheet financ-

ing.2 Thestudy estimated that

approximately $1.25 trillion in

off-balance-sheet leases existed

among SEC registrants at

thattime.

Shortly after the SEC

staff study was completed,

the Financial Accounting

Standards Board (FASB) and

International Accounting Stan-

dards Board (IASB) added

a project on accounting for

leases to their agendas as part

of their convergence initiative.3

And after nearly a decade of

work, the Boards have issued

their respective standards on

accounting for leases.4

The Boards achieved con-

vergence on the definition of

a lease, that lessees should

recognize substantially all

leases on balance sheet, and

that lessor accounting should

not be significantly revised.

But the Boards did not achieve

complete convergence. Most

notably, the “Day 2” lessee

accounting differs between

the Boards’ respective models.

While the adoption of these

new standards can have exten-

sive implications on companies,

the most significant conse-

quence on most companies is

likely to be the requirement for

lessees to recognize operating

leases on their balance sheets.

DEFINITION OF A LEASE

Accounting Standards

Update (ASU) 2016-02

defines a lease as a contract,

or part of a contract, that

conveys the right to control

the use of identified property,

plant, or equipment (an identi-

fied asset) for a period of time

in exchange for consideration.

Control over the use of the

identified asset means that the

customer (lessee) has both (a)

the right toobtain substantially

all of the economic benefits

from the use of the asset and

(b) the right to direct the use

of the asset. While those two

conditions appear similar to

the requirements under cur-

rent U.S. GAAP,5 differences

will exist. Most significantly,

the new definition focuses on

whether the customer has the

right to control the use of an

identified asset rather than

focusing on the right to access

the output and an obligation to

pay for that output. The new

definition attempts to align

more closely to the conceptual

framework definition of an

asset6 and focuses on both a

benefits element and a power

element to evaluate whether the

customer (lessee) has control of

the identified asset.

In most cases, a customer

(lessee) will have the right to

direct the use of an identified

asset if it can direct how and

for what purpose the asset

will be used throughout the

lease term by controlling the