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Preparation Levels for Lease Standard Proves Mixed

Published Date:
Mar 5, 2014

Though the Financial Accounting Standards Board (FASB) is set to release its long-awaited overhaul of lease accounting rules sometime this year, many entities say they are still behind in efforts to prepare for the new standard. 

In a survey of 138 executives released by Deloitte in January, just 1 percent of respondents said that they were “very” or “extremely” prepared for the new standard, down 9 percent since the last time the firm took this survey in 2011. What’s more, nearly 80 percent of business leaders said that they expect to have difficulties complying with the new standard. 

As it currently stands, the proposed FASB standard would divide leases into Type A and Type B categories, both of which would be expressed directly on the balance sheet. In the past, investors have complained that off–balance sheet leases can obscure the true face of a company’s finances. However, the new requirement has given some companies pause, since it would add complicating factors to everything from loan covenants to regulations that take what’s on the balance sheet into account. It also presents possible new IT challenges when it comes to classifying or reclassifying already existing leases. 

Type A would generally consist of most nonproperty leases, such as vehicles, aircraft or equipment. If a lease is considered Type A, then a CPA would recognize the right-of-use asset and lease liability, initially measured at the present value of lease payments and, secondly, the unwinding of the discount on the lease liability as interest separate from the amortization of the right-of-use asset.  

By contrast, however, leases for assets such as land, buildings or parts of buildings would be considered Type B leases. As with a Type A lease, the preparer would recognize a right-of-use asset and a lease liability initially measured at the present value of the lease payments. But unlike Type A leases, a CPA would recognize a single lease cost that combines the unwinding of the discount on the lease liability with the amortization of the right-of-use asset on a straight-line basis.

The proposed standard is part of the convergence project—a joint effort between the FASB and the International Accounting Standards Board (IASB) to produce a unified set of rules that can apply to both U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS). It has gone through numerous revisions since it was first released in 2010; the original draft of the standard attempted to replace the current operating lease vs. financing lease model with a unitary “right-of-use” model for all leases, but was widely criticized as adding unnecessary complications. Indeed, in a Dec. 15, 2010, comment letter, the NYSSCPA said the initial draft added unnecessary layers that would be of little benefit to the end users of financial statements. 

The standard was formally reproposed last May. It’s expected to be finalized within the first half of the year and take effect by 2017. 

Creating a game plan

Some NYSSCPA members that The Trusted Professional spoke to said the key to helping clients prepare for the proposed standard is to take a proactive approach. 

Adam T. Lazarus, a member who primarily serves clients in the real estate industry, said that his firm has been working to educate companies as to what the lease standard might mean for them, particularly when it comes to their loan agreements; even though they are private entities, he said, many still use GAAP for their loan covenants. He added that he has also been advising clients drawing up new agreements to specify which GAAP they are using, so that even if the standard changes in the future, the loan agreement will still reference GAAP as it was when it was first drawn up.  

“People going through loan agreements now should be adding ‘current GAAP’ to their loan agreements, [meaning] the GAAP currently in effect, because no one thought it would change like it is,” Lazarus said.  

Another part of the client preparation process, said Frank Romano, who works at the same firm as Lazarus, has been to assist with procedures and policies, particularly in the realm of internal controls. This, he said, ensures that data are properly recorded, given that businesses following GAAP rules would need to differentiate between leases in a new way. He noted that some businesses automate this sorting; if they do, he said, the system will need to be adjusted so that it’s done in accordance with the new standards, when they are finalized. 

Lazarus added that some of his real estate clients were already looking to move away from GAAP and that “this is just adding fuel to the fire.” For smaller entities without a lot of accounting resources, he said that filing in GAAP might not even be a possibility with the new standard, and they may drop it in favor of alternative bases of accounting. 

Victor J. Mizzaro, a member of the Real Estate Committee, said that his firm has also been examining when it might be more appropriate to move to tax basis reporting instead of GAAP, as “it can be less expensive for the client.” 

Still, Lazarus felt that since the proposal has been somewhat stop-and-go since it was first released in 2010, it may have given entities a sense of uncertainty about whether now is the time to actually start major preparations. Abraham E. Haspel, a member of the Financial Accounting Standards Committee, said that many of his clients have taken a wait-and-see approach.  

“The consensus among my clients is that they are waiting for the lease standard to be finalized because of the surrounding controversy and the likelihood that the standard for private companies will require implementation after 2017,” Haspel said. 

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