Accounting for leases Essay

AbstractThis paper depart provide an overview of fill write up. It will build the history, current status, and future implications of the latest proposed warning, as jointly issued by the fiscal Accounting Standards wit (FASB) and the International Accounting Standards Board (IASB). Furthermore, the paper will take into key out relevant observations made by various proponents who argon concerned virtually the ideal, and conclude with a personal opinion on the standard and why its get out than the current standard.Existing story statement standards between the financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) encounter allowed corporations to turn away spread abroading assets and liabilities via operating reads. Thus, it has become common intrust for corporations to utilize these operating pick outs as a source of deceptive financingby being able to materially mislead creditors and investors due to shoot equilib rium sheet accountancy. involve accounting is a classic typesetters case (or phenomenon) that shows how people tend to exploit accounting standards in regularize to reveal the substance over form accounting principle (where the scotch naturalism asshole be distorted from the legal domain).The history of permit accounting is an interesting one. In 1976, FASB re rentald Statement of Financial Accounting Standards (SFAS) No. 13 Accounting for leases. Since then, the accounting standard allowed companies to report approximately leases as an asset and a liability (i.e. capital/finance leases), and new(prenominal) leases as a non-asset and non-liability (i.e. operating leases). However, since the FASB-IASB convergence project began (from the 2002 Norwalk Agreement), they have reached a general consensus with investors that in many instances, operating leases base be misleading and could cover up material amounts of credit pretend of a given company.It is interesting to br and that such an issue had already been acknowledged by the late 70s, shortly after FASB released SFAS 13 (Kieso, Warfield, & Weygandt, 2004, p.1119). The issue was momentarily brought up over again during the proterozoic 90s for resolution, but was sharply protested by corporate interests and later on dismissed (Norris, 2013). Only now, has there been serious reconsideration of the standard and can demonstrate how long it can take for accounting standards to respond make unnecessary going to the needs of financial statement utilisers.On June 16, 2005, the US Securities and Ex alter outfit (SEC), in response to the Sarbanes-Oxley Act (SOX) of 2002, publically released On Arrangements with Off-Balance Sheet Implications, spare Purpose Entities, and Transparency of Filings by Issuers. This public statement proposed several heavy goals and recommendations, among them a proposal of marriage to improve accounting for leases. By July 2006, the FASB and IASB established a Work Pl an, in order to improve the standard for lease accounting (Work Plan for IFRS Leases, 2013). The project has yet to be completed. Details about its current status will be described contiguous.On may 16, 2013, FASB-IASB has released their latest expo indisputable draft on accounting for leases. Based on user feedback, this draft arose from earlier draft iterations that were released in March 2009 and deluxe 2010 ( pictorial matter Draft, 2013, p. 1). If approved, the draft would supersede IFRS IAS 17 and FASB Topic 840 ( depiction Draft, 2013, p. 2). As a result of this draft, FASB-IASB will also attempt to concurrently update revenue recognition standards accordingly, as the latest proposal intends to make sure theaccounting for revenues and expenses for many(prenominal) the lessor and lessee will be consistent with each other ( movie Draft, 2013, p. 1). Furthermore, there are silent some minor differences that endure between the FASB and IASB drafts, among them being revalu ations, cash flow, disclosure, non-public entities, and measurement issues ( picture show Draft, 2013, pp. 4-5). The feedback deadline for this draft is family 13, 2013 (Exposure Draft, 2013).As it turns out, this draft decided to take a oft convictions more prudent approach (compared to earlier proposals) towards lease accounting, allowing standards similar to SFAS 13 to remain applicable in practice for any leases that have footing of 12 months or less or if it is a Type B lease (which will all be further explained below) (Exposure Draft, 2013, p. 3). In core, this would allow lessors to continue to structure their lease terms accordingly, which allows lessees the ability to restore these short-run leases in order to continue to practice off balance sheet financing.So whats the current proposal to account for lease terms that are more than 12 months? First, the exposure draft would read entities that enter such a leasing contract to recognize the right of use asset and its a ssociated liability (Exposure Draft, 2013, p. 2). Second, the draft requires the entities to recognize the underlying genius of the asset as being either Type A (non- topographic bespeak) or Type B ( office) (Exposure Draft, 2013, p. 2). Third, the draft requires the lessee to assess how much scotch benefit it reasonably expects to derive from the right of use asset (Exposure Draft, 2013, p. 2). Furthermore, the draft has guidelines for both the lessee and the lessor. These accounting guidelines will be described nextfirst for the lessee, then for the lessor.For the lessee, if the lease is Type A, the lessee is required to recognize the associated contract Asset and Lease Obligation on the Balance Sheet (Exposure Draft, 2013, p. 2). The asset could be depreciated, and the respective portions of the Lease Obligation are to be listed under the Liability and Debt sections of the balance sheet, respectively. The asset and associated liability is to be ab initio measured by using t he attest evaluate method (where the initial account balances chew overs the arrange value of the future amount) in order to account properly for liaison Expense payments made during the whole course of the Lease Obligation (Exposure Draft, 2013, p. 2). The lessor is required to de-recognize the Leased Asset from the Balance Sheet. In its designate, the lessor must recognize the Lease Receivable and Residual Asset (Exposure Draft, 2013, p. 3). The assets are also initially measured using the same present value method, in order to account properly for the interest gain apart from the Lease Revenue throughout the whole term of the lease (Exposure Draft, 2013, p. 3).If the lease is Type B, the exposure draft proposes that both the lessee and the lessor should account for the lease as an operating lease if the lessee is NOT expected to train more than an insignificant portion of the economic benefits embedded in the underlying asset (Exposure Draft, 2013, p. 3). Thus, the lessor w ould continue to recognize the underlying asset, while the lessee alone account for the annual lease expense (Exposure Draft, 2013, p. 3). Again, this accounting preaching is the same for any leases that have terms of 12 months or less. arrest in mind however, that if the lessee were to consume a significant portion of the economic benefits under a Type B lease, the accounting treatment for both the lessee and lessor would be similar to a Type A lease (Exposure Draft, 2013, p. 2). In this case, the lessee would be required to recognize an asset and liability from the property lease. I believe such proposal was intended, as it allows companies to gradually line up to the new treatment standards, whereby future amendments could someday require all short-term leases (and Type B leases) to be profitd to better reflect the economic reality of short-term lessees.So, what do the proponents of the exposure draft think of the new standard and its impact on the future? As expected, there a re some who agree with the draft and others who think other keen-sighted. Dhaliwal, Lee, and Neamtiu (2011) did a quantitative and qualitative data-based studyof which evidence suggests that lessees bear insufficient risk to treat the leasehold as an asset (p. 193). This implies that the new proposal would not significantly summation the toll of capital for any firms that would have to start capitalizingtheir operational leases. Cotton, McCarthy, and Schneider (2012) found that nearly firms under current lease accounting are able to mix in associated obligations from their capitalized leases with other obligations (p. 118).This would not be allowed under the new proposal, and then change transparency and quality of information to investors. Middelberg and Villiers (2013) did a similar study, of 40 JSE-listed (South Africa) companies. Interestingly, their findings inside this study suggest that the cost of financing would increase for firms that would have to capitalize operat ing leases. Their findings suggest that companies should expect to experience the following changes to their financial ratios Debt-to-equity to increase by 9%, Debt ratio to increase by 8%, and the Interest cover ratio to decrease by 8% (Middelberg & Villiers, 2013, p. 663). This implies that the new proposal would cause investors to see such companies as high investment risks, thus increasing borrowing cost. Burton (2013) doesnt believe in the new proposal, or else suggesting that the current standards be amended to address the areas that are vulnerable to exploitation.He thinks the FASB should consider revising the four criteria provided in SFAS 13 that determines if a lease should be capitalized. In particular, he encourages the FASB to change the 90% present value rulewhich currently impose no such requirements for lessors to reveal the actual discount rate to the lessee. As a result, lessors are able to keep the leased asset on their books as a capital lease by using a low d iscount rate, while the lessee can use a higher, in-house discount rate in order to avoid the need for capitalizing the lease. Quah (2013) reasoned that the proposed changes could have a more significant effect on retailers, as they are known to have major property leases. In particular, she notes that as the liabilities increase from capitalizing such leases, it would have negative make on debt, employee compensation, and tax balances.This could cause major implications, as retailers (department stores, discount chains, whatsis stores) are key economic players in the economy. Similarly, it would effect other major industriessuch as real-estate, major airlines, and shipping firms. Norris (2013) made a point that the new proposal could cause some revenue (income statement) challenges, as the present valuation methods would cause lessees to incur higher interest payments during the earlier days of the leased assets. This could especially be disappointing for earlybusiness startups (that typically need to take out more loans) and for any firms needing to maintain a lower cost of capital (that they would have otherwise been able to realise under operational lease accounting). Taken all together, the aforementioned observations fundamentally imply that the future impact of the new proposal on lease accounting would effect all the major players within the economy, especially the retail, real-estate, and conveyancing industries.Furthermore, there is likelihood that higher borrowing costs would result for some of these businesses, forcing them to possibly reduce employee benefits and/or compensation in order to better align their financials to ever-changing budget forecasts. On the other hand, investors will have access to higher quality, transparent informationreducing perplexity and risk to maintain lower interest rates. And as I mentioned earlier, the proposal still gives lessors and lessees the opportunity to restructure their lease terms for annual renewal , avoiding the need to capitalize such leases and to keep them off the books. But by doing so, it would imply higher legal costs for some of these lessors and lessees, and thus, act as a baulk in support of the new standard for capitalizing leases. I feel the FASB-IASB is wise to have taken a more balanced approach for changing the requirements of lease accounting.By doing so, it allows the majority of companies to readjust their accounting policies to better reflect economic reality (instead of legal reality). Also, the more transparent and specific requirements utter in the proposal for reporting liabilities and debt in the financial statements will have a long-run, positive impactas it ultimately helps reduce uncertainty between investors and reign overment. I feel these benefits will outweigh the costs (including the transitional-related costs that entities would have to pay in order to update their accounting policies and methods). Besides, these new accounting costs will be reduced over time anyway, as firms become accustomed to the new standard. In summary, by forcing companies to report more honestly to investors, it induces management to better utilize their resources in order to maintain healthy margins, instead of resorting to fraudulent activities.Thus, I believe that the standard is a win-win for both internal and external parties, as it better forces them to manage their resources more responsibly, and prevents management from supporting an exploitative culture that had been taking place during the past 25+ yearswith the old standard.ReferencesBurton, D. (2013, may 22). Lease-Accounting Rules Tinker, Dont Trash News Article. Retrieved high-flown 24, 2013, from LexisNexis Academic database. Cotton, B., McCarthy, M.G., & Schneider, D.K. (2012). A METHODOLOGICAL FRAMEWORK FOR EXAMINING knowledge CONTENT OF PROPOSED LEASE ACCOUNTING RULE. Journal of Theoretical Accounting Research, pass away 2012, Vol. 8 Issue 1, 113-127. Dhaliwal, D., Lee, H. S., & Neamtiu, M. (2011, April). The Impact of direct Leases on Firm Financial and Operating Risk. Journal of Accounting, Auditing & Finance, Vol. 26 Issue 2, 151-197. Financial Accounting Standards Board. (2013, May 16). Exposure Draft Leases (Topic 842) PDF Document. Retrieved August 24, 2013, from http//www.fasb.org/cs/BlobServer?blobkey=id&blobnocache=true&blobwhere=1175826935767&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobs Kieso, D.E., Warfield, T.D., & Weygandt, J.J. (2004). medium Accounting 11e. Hoboken, NJ John Wiley & Sons, Inc. Middelberg, S.L., & Villiers, R.R. (2013, June). Determining The Impact Of Capitalising Long-Term Operating Leases On The Financial Ratios Of The Top 40 JSE-Listed Companies. International Business & economics Research Journal. Jun2013, Vol. 12 Issue 6, 655-670. Norris, F. (2013, May 17). Accounting boards try again on leases Revamped proposal for valuing assets would still be a radical change News Article. Retrieved August 2 4, 2013, from LexisNexis Academic database. Norris, F. (2013, May 17). New Accounting Proposal on Leasing Portends Big Change News Article. Retrieved August 24, 2013, from LexisNexis Academic database. Quah, M. (2013, May 18). New proposals on lease accounting under fire Some say they are a compromise, while others feel they will raise costs for firms News Article. Retrieved August 24, 2013, from LexisNexis Academic database.