What Lessors Need to Know About Proposed Changes in Lease Accounting: The Performance Obligation Approach

This is the fourth and last in a series of blogs on lease accounting. Previously, we’ve provided an overview of proposed changes, and looked at the impact on lessees and on lessors using the derecognition approach. In this last entry, we stay with lessors, but this time with lessors using the performance obligation approach. Here’s what lessors need to know: The performance obligation approach should be used whenever the lease exposes the lessor to significant risks and benefits associated with the leased asset.

Recognition and Measurement

On the balance sheet, the lessor would recognize a lease receivable at the present value of the discounted future lease payments and a lease liability equal to the lease receivable. In subsequent periods, the lease receivable and lease liability should be measured at amortized cost. The lease liability should be amortized based in the pattern of use of the related asset. If the pattern of use is not easily determinable, the straight-line method of amortization should be used. Interest income related to the lease receivable and lease income recognized as the lease liability is satisfied should be reported on the income statement. Any changes to the lease liability or impairment losses on the lease receivable should also be recognized on the income statement during subsequent periods.

Presentation in the Financial Statements

A lease receivable, the leased asset, and a lease liability should be shown separately on the balance sheet netting to a total lease asset or liability. Interest income, lease income, and depreciation expense of the lease asset should be shown separately on the income statement totaling to a net lease income or expense. The repayments of the lease receivable and interest income should be classified as an operating activity on the statement of cash flows.

Transition to the New Standards

On the date of initial application of the proposed new guidance, the lessor should recognize a lease receivable for all outstanding leases at the present value of the remaining lease payments and a lease liability equal to the lease receivable. Any previously derecognized assets related to outstanding leases should be recognized at depreciated cost.

Stay Tuned to Gray Matter

On August 17, 2010, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued Exposure Drafts on Leases. The Exposure Drafts are part of the FASB and the IASB’s convergence project to create a more unified set of accounting standards. The proposed new guidance will dramatically change the way leases are recorded on the financial statements of both lessees and lessors. We will keep you posted as the exposure drafts move from the draft stage to actual regulation.