The Financial Accounting Standards Board (FASB) on August, 17, 2010 released their “exposure draft” requiring companies to record nearly all leases on their balance sheets as a “right to use” asset, and a corresponding “future lease payment – liability”.; What does this mean to your business in layman terms?; This proposal in essence does away with operating leases; all leases (unless immaterial) would be capitalized using the present value of the minimum lease payments.; Therefore, businesses who in the past had off-balance sheet lease obligations, must now record these obligations on their balance sheet.
A key point to consider with regards to the proposed lease accounting changes is that, in all likelihood, existing operating leases, signed prior to the implementation of the new rules, will require reclassification as capital leases that must be accounted for on the balance sheet. Since operating lease obligations can represent a larger liability than all balance sheet assets combined, lease reclassification can significantly alter the businesses balance sheet.
Part of the purpose for this is to coordinate lease accounting standards with the International Accounting Standards Board (IASB), which sets accounting standards for Europe and many other countries. Both, however, have the concept of capital (or finance) and operating leases, however the dividing line is drawn between such leases.
Addendum – Definition of Capital and Operating Leases:
The basic concept of lease accounting is that some leases are merely rentals, whereas others are effectively purchases.
Operating leases do not normally affect a company’s balance sheet. If a lease has scheduled changes in the lease payment (for instance, a planned increase for inflation, or a lease holiday for the first six months), the rent expense is to be recognized on an equal basis over the life of the lease. The difference between the lease expense recognized and the lease actually paid is considered a deferred liability (for the lessee, if the leases are increasing) or asset (if decreasing).
;1) The lease conveys ownership to the lessee at the end of the lease term;
FASB Proposed Lease Accounting Changes – Impacts on Commercial Real Estate
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