Unifying Accounting treatment of Leases

The Financial Accounting Standards Board (FASB) of USA and the International Accounting Standards Board (IASB) have been collaborating in an effort to eventually unify accounting standards worldwide.

FASB and IASB long term plan is for the convergence of the differing accounting standards currently used around the world. This will lead to increased comparability of accounting information globally. This will be a huge benefit for potential investors, lenders and users of financial statements.

One area of particular importance is the treatment of leases. Leasing is an important activity for many entities and that includes not-for-profit organization. It generally means that the entity gains the usage of an asset that it would otherwise not be able to afford. Examples may include assets such as real estate, vehicles, capital goods for manufacturing etc. Since leasing is common today, it becomes increasingly important for the users of the financial statements to understand how these leased assets are treated in the Balance Sheet.

The existing accounting guidelines for leases require lessees and leasers to classify their leases as either capital leases or operating leases. The accounting treatment for capital and operating leases are quite different. A lease of an asset can be treated as a capital lease by one entity and as an operating lease by another depending on the size of the two companies. One could capitalize the lease and it will appear in the Balance Sheet and another will write off the same lease as an operating lease in the Profit and Loss account. Therefore accounting guidelines for lease have been criticized for failing to meet the needs of users of financial statements for this very reason.

Joint Project of the FASB and the IASB for leases

The objective of the joint project is increased transparency and to enhance the comparability among entities of lease assets and liabilities in the balance sheet and the disclosure of important information in the notes to accounts on the treatment adopted for greater clarity.

The core principle is that the assets or liabilities as a result of a lease should be
recognized by an entity as against the current accounting standards that give an entity
some leeway for not recognizing the leases as such. This is an improvement. Any lease
for a possible term of more than 12 months is to be recognized by the lessee and be disclosed in the Balance Sheet.

The basis of recognition is based on whether the lessee is “expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset”.

In response to the above proposal, the AICPA disagrees with the “test” that would determine the nature of a lease and has offered an approach that refines the basis of recognition of leases to be classified into Type A or Type B lease.  They content that the “more than an insignificant portion” test is relatively more complex and suggested that the test be simpler and be based on the “economics” of a lease instead of the “property”.

Financial preparers and others have voiced their concern on the proposals being too complex and costly to implement.

No one is in doubt that the approach taken and efforts expended for the convergence of the accounting standards for leases is wasted and that a common ground will become apparent in the near future.

 


Copyright 2018