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By Robert N. Gray, CPA

During 2013, the Financial Accounting Standard Board (FASB) and the International Accounting Standards Board (IASB) began a project to address the accounting and reporting for leases. The focus was two-fold: (1) the balance sheet should reflect the obligation rather than simply disclose the obligation in a note to the financial statements, and (2) more effort to converge U.S. and international accounting standards should be made. The boards issued proposed changes to accounting standards which, very simply, made substantially all leases capital leases – the acquisition of property and equipment using lease financing. The reception for the proposed changes was quite mixed.

During April 2015, the FASB met to discuss the accounting and reporting for leases. The following is a summary of the current status and plans of the FASB, with a focus on accounting and reporting by lessees.

The FASB and the IASB have agreed to disagree on several aspects. Basically, the IASB has gone the way previously discussed where substantially all leases will be treated as capital leases. FASB, however, has heeded many of the complaints found in comment letters to earlier exposure drafts and adopted a “dual approach” with the focus on showing a right-of-use asset and lease obligation liability on the balance sheet for all leases.

The FASB will classify leases based on criteria similar to current GAAP. There will be a “financing lease” (similar to a capital lease today) for which there will be a lease asset and a lease liability on the balance sheet, and the income statement will reflect interest and depreciation rather than rent expense. No big change here. These will be referred to as Type A leases.

All other leases will be classified as Type B leases (operating leases today). There will be an asset and a liability for the present value of the lease payment on the balance sheet. However, the amortization of the asset and liability will be combined as one rent expense, not depreciation and interest, recognized on a straight line basis similar to current GAAP.

This revision from earlier exposure drafts by the FASB should eliminate the concern of government contractors with cost-reimbursable contracts regarding unallowable interest. It also appears this would eliminate any impact on IBITDA for purposes of financial covenants and other measurements. But balance sheet ratios will still be blown away with the new asset and liability for operating leases.

The above is an oversimplification. There will be new terminology, additional disclosures, and transition rules. Also, accounting by lessors is addressed separately. In addition, the standard will address lease modifications, sale-leaseback transactions, build-to-suit leases, variable or contingent rent, etc.

The FASB currently plans to issue a final statement by the end of 2015. There is no indication yet of a likely effective date.

We will update you on any significant changes in this accounting issue. But given the earlier proposals, the current development is good news, especially for government contractors.

Robert N. Gray, CPA, is a shareholder in Rubino & Company, Chartered. Mr. Gray oversees the accounting and auditing practice for the firm and serves as the firm’s Director of Quality Control. He has over 40 years of public accounting experience and serves clients in a wide range of industries throughout the mid-Atlantic region.