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Implications and Preparatory Steps for Lessees
Despite the extensive rules that govern lease accounting, financial statement users often criticize the "bright-line" rules in existing standards for differentiating capital leases from operating leases. The primary criticism stems from the fact that current standards allow companies to structure leases to suit their financial reporting preferences; thus, companies frequently engage in complicated arrangements involving third-party guarantors in order to avoid reporting lease agreements as capital leases (i.e., to avoid recognizing the asset and the related liability in their financial statements). These rules permit companies to develop to leasing arrangements that cover multiple years with no balance-sheet recognition; thus companies widely utilize leases as a mechanism for off-balance sheet financing. In addition, comparability suffers because companies use varying accounting treatments for economically similar lease transactions.
To address these concerns, FASB and the IAS ? have joined forces to develop a comprehensive exposure draft, Proposed Accounting Standards Update (Revised), issued May 16, 2013, regarding Accounting Standards Codification (ASC) Topic 840, "Leases." If implemented, the exposure draft will replace ASC Topic 840; the comment period for the revised exposure draft ends September 13, 2013. If enacted, this standard would substantially reduce the opportunities for companies to use leases as off-balance sheet financing. (See Exhibit 1 for an illustration comparing the proposed standard and the current standards, as well as the goals of the exposure draft.)
The ensuing discussion explores the content of the revised draft, as well as the financial reporting implications for lessees, including transition rules and the steps that CPAs can take in planning for a potential new lease accounting standard. In considering possible financial reporting implications, two examples of companies that make extensive use of operating leases under current standards are presented. These examples illustrate the nature of the changes that a new leasing standard could have on companies' balance sheets.
CPAs can start preparing for this proposed standard by familiarizing themselves with its provisions and by preparing for compliance with the new standard. Although the new exposure draft recommends significant changes to both lessee and lessor accounting, this article focuses on lessees.
Revised Exposure Draft
The overriding theory behind the exposure draft is that when a lessee enters a lease with a term of one year...