FASB and IASB at Odds Over Lease Accounting Standard

For the last decade, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have tried to develop a global standard for reporting leases. They agree that lease obligations should appear as liabilities on the balance sheet, a major change from current practice. But the boards are at loggerheads over how to report lease expenses on the income statement. Here’s a look at the current debate and the potential outlook for the lease accounting standard.

Casting light on leasing obligations

FASB and the IASB initiated their overhaul of lease accounting rules in response to years of criticism that companies kept lease expenses off their balance sheets and hid massive liabilities. The overhaul would make airlines, retail chains and countless other businesses around the globe own up to the expenses they have tied up in commitments to rent office space, warehouses, equipment and vehicles. In 2005, the Securities and Exchange Commission estimated that more than $1.25 trillion would be shifted onto company balance sheets if lessees had to record the amounts they owe for renting stores, cash registers and heavy equipment.

Last year, the accounting boards issued mostly converged proposals on how to report long-term lease contracts. But these proposals have been met by significant opposition, especially from businesses that don’t want to alter established reporting practices or report more debt to stakeholders.

Failing to achieve consensus on expenses

FASB and the IASB agree that almost all lease contracts of more than 12 months should be recorded as liabilities on company balance sheets. The differences lie in how to report the expenses on the income statement.

The IASB wants all lease expenses to be treated as financing transactions, meaning interest and amortization would be calculated with rent expense. Because interest is calculated on a declining balance over time, the cost to rent a piece of equipment would look more expensive at the beginning of a lease. Many companies say such accounting treatment will make them look more leveraged than they are and diminish their market value and creditworthiness.

On the other hand, FASB views some lease arrangements as financing transactions and others as simple rentals. Companies with rental-type contracts would report payments evenly over time. Businesses would decide how to account for their leases based on what the IASB believes is an arbitrary dividing line that will make the accounting more complex, which is counter to one of the project’s goals — to simplify financial reporting.

It may seem that consensus on how to draw up the balance sheet may do enough to improve current accounting. But having differences in the income statements of companies that follow U.S. Generally Accepted Accounting Principles (GAAP) vs. International Financial Reporting Standards (IFRS) will complicate the work done by analysts who consider net income and non-GAAP measurements, such as earnings before interest, taxes, depreciation and amortization (EBITDA), to be key indicators for valuing companies.

Multinational companies and their accountants also would have to deal with the headaches of reporting under two different regimes. As convergence unravels, it’s not clear how — or if — the boards will finalize the project.

Agreeing to disagree

Rather than develop a landmark global standard that applies to all long-term leases worldwide, the accounting boards seem to be settling for “minimizing differences between U.S. GAAP and IFRS.” The focus has shifted to addressing second-tier leasing issues, such as lease modifications, variable lease payments, discount rates and whether to exempt small-ticket leased items, such as photocopiers and coffeemakers, from the new rules.

Final lease rules could be released in 2015 — if FASB and the IASB can compromise on less significant, second-tier leasing issues. But first, the boards will have to hash out presentation, disclosure, transition, the new standard’s effective date and other remaining issues. Separately, FASB has to discuss private company and not-for-profit accounting issues.

Accounting for leases in the future

While the future of leasing accounting remains undecided, one thing is clear: The boards have no plan to revisit the income statement issue anytime soon. The sharp division between FASB and the IASB on this issue underscores the complexity of lease accounting and how the final standard — if there is one — may not be palatable to everyone.

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