January Update on Changes Coming in Accounting for Leases

By Robert N. Gray, CPA

During 2013, FASB and the IASB began a project to address the accounting and reporting for leases. The primary focus was to have the balance sheet reflect the lease obligation rather than simply disclose the obligation in a note to the financial statements. 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, especially within the government contracting community that was concerned the imputed interest expense for the lease obligation would likely be an unallowable cost under the FAR rather than allowable rent expense.

During April 2015, the FASB and the IASB agreed to disagree. During November 2015, the FASB gave preliminary approval to issue a new standard on accounting for leases. Following is a brief overview of the model proposed by the FASB.

For lessees, the FASB decided to adopt a “dual approach” with the focus on showing a right-of-use asset and a lease obligation liability for the present value of the lease payments on the balance sheet for all leases. However, leases that would be classified as operating leases under current standards will be called Type B leases, and 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.

Leases that would be classified as capital leases today will be called Type A leases, 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.

For lessors, the FASB decided they should account for leases using an approach that is substantially equivalent to existing GAAP for sales-type leases, direct financing leases, and operating leases. The lessor should determine lease classification of a lease on the basis of whether the lease is effectively a financing or sale, rather than an operating lease, primarily by assessing whether the lease transfers substantially all the risks and reward incidental to ownership of the underlying asset. Type A leases will be those that are effectively financing or sales-type leases, and Type B leases will be operating leases.

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 FASB currently plans to issue a final statement in early 2016. The new standard is expected to take effect for public companies in fiscal years beginning after December 15, 2018, and for private companies and not-for-profit organizations, the standard is expected to take effect for fiscal years beginning after December 15, 2019. Early adoption will be permitted.

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.