New Lease Accounting Rules Could Significantly Change Balance Sheets

Proposed new guidance from the Financial Accounting Standards Board (FASB) could require all companies to record lease obligations on their balance sheets.

The proposed new rules are intended to provide better information and more transparency for investors. These changes are a joint effort between the FASB and the International Accounting Standard Board (IASB) that have been under way for over a decade. The FASB issued the latest exposure draft in August for public comments until mid-December. Final issuance is tentatively scheduled for mid-2011 with effective dates as early as 2012.

Current accounting practice divides leases into two categories: capital and operating leases. Capital leases record the asset and related liabilities on the balance sheet; however, operating leases are disclosed in the footnotes to the financial statements including general terms and total obligations over the term of the lease. Under the FASB proposal, these operating lease obligations are required to be recorded on the balance sheet. Industry experts have estimated this unrecorded obligation to range anywhere from $650 billion to $2 trillion.

The new guidance will apply to both lessees and lessors and to all leased assets with a few exceptions. A lease will now be defined as a contract where the “right to use” a specified asset is conveyed for a period of time in exchange for consideration. The lease term no longer is just the base term but would require an estimation of the longest possible term that is more likely than not to occur.

While the new guidance applies to all companies, clearly the more burdensome compliance will fall on those with heavy concentrations in leasing such as retail, airlines, trucking and commercial real estate. These businesses should begin the process of understanding the impact of the new accounting rules on their financials. Check back for regular updates as the new guidance is finalized.