Economical sciences/7. Accounting and audit
Bozhina A.A.
National
University of Food Technologies, Kiev, Ukraine
The
Financial Accounting Standards Board ("FASB") and the International
Accounting Standards Board ("IASB") are proposing dramatic changes to
lease accounting rules that would virtually eliminate operating lease
accounting treatment. The changes would affect all companies that lease real
estate, and their company balance sheets, as a result of how leases would be
classified under the proposed new rules as a capital lease transaction.
The proposed standard will virtually eliminate
operating lease accounting treatment for leases greater than one year in
duration. For companies that lease real or personal property as either lessors
or lessees — this broad swath includes most companies — the changes will affect
how leases are accounted for on the company’s financial statements.
One of the goals of the proposed revisions is to improve transparency in
the financial reporting of lease transactions. Under current FASB lease
accounting rules, tenants are required to classify their leases as either
capital leases or operating leases. The vast majority of leases are treated as
operating leases. Under operating leases, the lease payments are considered a
rental expense and there is no asset or liability recognized on the balance
sheet. Capital leases, on the other hand, treat the tenant more like the owner
of the leased property and the lease as a means to finance the acquisition of
the leased property. Consequently, lease payments are treated as a liability
over the term of the lease and the right to use the leased property as an
asset.
Under
the proposed accounting standard change, lessees will now have to recognize
assets and liabilities for leases on the company’s balance sheet. The
recognized asset will be the right to use the underlying asset, whether it be
real or personal property. The recognized liability will be the obligation to
make lease payments during the lease term. The proposal includes two approaches
to accounting for the assets and liabilities of the lease for lessees: (1) if
the lease term is for a major part of the economic life of the underlying asset
or the present value of the fixed lease payments accounts for substantially all
of the fair market value of the underlying asset, then the company must
front-load the expense of the lease as a liability on the balance sheet (most
equipment leases); or (2) if the lease term is an insignificant portion of the
economic life of the underlying asset or the present value of the fixed asset
payments is insignificant relative to the fair market value of the underlying
asset, then the company must use a straight-line approach, which would allocate
the lease payments evenly over the lease term as a liability on the balance
sheet (most real property leases).
The potential impact from these accounting rule modifications will
manifest themselves in a number of ways, including but not limited to: (1)
balance sheets: tenants will have to recognize assets and liabilities for
leases where in the past, as an operating lease, they did not; (2)
owning/leasing property: the distinction between owning and leasing property
will diminish leading companies to perhaps look more favorably upon owning
property rather than leasing; (3) lease terms: lease terms will be shorter
without renewal options to avoid putting more debt on tenant balance sheets;
and (4) loan covenants: tenant balance sheets will look more leveraged which
may result in a tenant not being in compliance with loan covenants.
The proposal also includes two approaches to accounting for the assets
and liabilities of the lease for lessors. Lessors will have to distinguish
between leases to which the receivable, and residual approach applies and
leases to which an operating lease accounting approach applies.
Once the final rules are adopted, the new accounting standard will
increase financial liabilities reflected on balance sheets, forcing creditors,
investors, business owners and others to reconsider the common calculations
used to determine fiscal health. Standard fiscal covenants that will likely be
affected include EBITDA and debt-to-equity ratios. Companies who currently have
credit agreements or other financing arrangements — whereby the company has
agreed to certain debt covenants in exchange for a line of credit or financing
— may need to speak with their lenders and accountants in order to make sure
that the new lease accounting standard will not automatically put the company
in breach of its current debt covenants. If so, the company may need to engage
legal counsel to renegotiate the terms of the debt covenants with its lenders.
A recent survey, conducted by accounting firm Grant Thornton of 2,800
businesses across the globe, found that 54% of businesses "are not aware
of, and are therefore unprepared for, one of the most significant global
accounting changes in the past decade: the virtual elimination of off-balance
sheet leases." The Securities and Exchange Commission estimates that the
accounting changes would lead public companies to put $1.3 trillion in leases
on their balance sheets.
As a result of the increased liabilities on a company’s balance sheet,
there could be an increase in real estate and equipment purchases as opposed to
leasing arrangements. At a time of record low interest rates and a diminution
in property values, companies may seek to purchase assets as opposed to
leasing.
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