The US Financial Accounting Standards Board (FASB) has voted to proceed with a new accounting standard that would require companies and other organizations to include lease obligations on their balance sheets. The new accounting standard is being proposed following concerns regarding the lack of transparency relating to material lease obligations that have been reported off-balance sheet.
The final Accounting Standards Update (ASU) is expected to be published in early 2016 and will be effective for public companies for fiscal years beginning after 15 December 2018; for private companies, the standard will be effective for annual periods beginning after December 15, 2019.
The FASB added that early adoption will be permitted for all companies and organizations upon issuance of the standard.
As a next step, the FASB staff will complete a “ballot draft” of the ASU that includes all of the Board’s final decisions.The ballot draft will be shared with each of the seven FASB members who will review it to ensure that it accurately reflects decisions made throughout their public deliberations. When the FASB is satisfied that the ballot draft reflects its intentions, the draft will be submitted to production for final publication.
“We believe that this new standard is important because it will provide investors, lenders and other users of financial statements with a more accurate picture of the long-term financial obligations of the companies to which they provide capital,” said FASB chairman, Russell G Golden.
The FASB wants to bring all leased assets onto the balance sheet, giving a more complete picture of a business’s financial position. If introduced, its proposals would require all publicly quoted companies and public sector organizations to account for the assets they lease – whether vehicles, computers or commercial property – giving greater transparency to investors.The most recent proposals seem to exclude leases incapable of lasting more than 12 months, however.
Historically, financial leases have had to be reported on the balance sheet, but not operating leases. The new approach to lease accounting, referred to as the ‘right of use approach’, differs substantially from today’s standard which is based on an analysis of the risks and rewards inherent in the lease.
Under the right of use model, a lessee would always recognize an asset, (the right to use the leased item), and a corresponding liability, such as the rental payment, on its balance sheet, whereas under the current standard, a lessee recognizes the leased asset only under finance leases with a note to the accounts for operating lease liabilities. Publicly listed companies already have to make a note to the annual report, which reflects any operating lease rentals payable.
The lease accounting rules only apply to publicly quoted firms that report to the International Financial Reporting Standards and the public sector. Businesses will need to ensure they report on their liabilities (rental payment arising under the lease) and their asset (the right to use the leased asset).
Bringing these leased items onto a firm’s balance sheet should not in itself erode the commercial benefits of leasing. Leasing has already proven its value, sheltering companies from the risks associated with the movement in vehicle values and ensuring that more capital remains available than when assets are purchased outright. But it will inevitably impose a new reporting burden.
Fleet Logistics, Europe’s largest independent fleet management provider, believes that the rule changes may herald a shift in the length of some lease vehicle agreements, especially for those clients who derive significant advantage from the current off balance sheet accounting principles.
Fleet Logistics CCO Vinzenz Pflanz, said the company was receiving a lot of enquiries from clients regarding the benefits of buying versus leasing vehicles, in the light of the proposed accounting standard.
“The new lease accounting standard seems to have taken a step further with this new announcement.
“If introduced, your company will need to ensure it reports its liabilities, that is the payments arising under the lease, along with the right to use the leased asset. This is relatively straightforward if you are able to measure these two values and account for them in a consistent and simple manner.
“However, it is possible that matters could get complicated if these values are treated differently or if you are required to make minor re-forecasting adjustments for leased items during a financial year, such as recalculating the length of a lease,” he said.
Pflanz said there were a number of exceptions to the proposed changes, mainly centered on short-term lease agreements of less than 12 months, which would remain off balance sheet.
“For those businesses that are sensitive to the change in accounting standards affecting longer term leases, there is the potential for shorter term contracts to become more appealing, especially on job need fleets, assuming the challenges of administration could be overcome,” he said.
Pflanz went on: “We are, of course, watching developments with interest on our clients’ behalf. We are already starting to review the implications of the way we report to clients, especially as there may be additional detail required in order to support your internal accounting standards.
“Ultimately, we will have to wait until the final Accounting Standards Update (ASU) is published in early 2016. Then we will have a clearer picture of the full implications of the new accounting rules and their impact on our clients,” he added.
Read the original article in Fleet Logistics’ November 2015 Newsletter.