New Rules for Lease Accounting: The Controversy The Accounting Lease Controversy

The Advantages of the new system

Voices Against the New Lease Accounting Model

The Accounting Lease Controversy

The International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB) jointly issued exposure drafts on August 17, 2010 proposing a new lease accounting paradigm. The EDs propose changes to simplify lease accounting and improve transparency. The new lease accounting model is based on the core principle that all leases gives rise to liabilities for future rental payments and assets that should be reported on the entity's balance sheet. The objective of the new approach is to ensure consistent lease accounting across sectors and comparability of financial reporting. This paper analyzes the economic impact of the proposed new lease accounting paradigm on the financial statements and derived financial ratios of the reporting entity (Accountancyage.com).

In 2013, the lease accounting world underwent a big change that has given rise to a controversy that is still raging on. The controversy is about whether to adopt the new system to lease accounting or not and whether it would be beneficial to the companies, firms, business organizations and accounting world.

Prior to the proposed new system, companies and business organizations were able to classify almost all the leases and lease agreements as operating leases and were thus able to not show them on their balance sheets. This is an established principle that the regulators and accounting critics have been criticizing for long. One examples that the critics put forward is in the case of airlines where airline companies put out all their airplanes on lease and then they do not show details or even mention these lease on the balance sheets as assets and therefore they also do not also show the money that the companies are liable to play in the future for the commitment to pay for the planes.

There have been hue and cry to remove this defect from the accounting system of leases and lease agreements and the showing of lease as assets I the balance sheets of companies which would give a better understanding of the liabilities of the companies and the gains made by the companies (Accountancyage.com).

Proponents of this new system that is aimed for the development of an improved standard for leasing is vital as the investors and the shareholders in companies are forced to take educated guesses about the liabilities that are hidden beyond what is revealed in the balance sheets of companies and business organizations that account from leasing activities.

The new rules for examples, would require an airline that has entered into a lease for a plane to identify and show the leased plane as an asset in the balance sheet and the right to use the plane along with the equal liability based on the current value of the lease payments that the airline has promised to make to the company from which it has leased the aircrafts. This would be similar to money being borrowed for business and which are mandatorily exhibited in the accounts and balance sheets (Bauman and Francis).

This format of accounting would enable the shareholders and the investors know the exact figure that the airline would owe to other companies and entities and thus make a far better judgment of the liability that is associated with the entire operations of the airline. Similar conditions are applicable for other business and their investors and shareholders.

This proposal for the accounting of lease has been long demanded by investors who want companies to show leases as liabilities and as such, those liabilities should be reflected on the balance sheets of companies.

There are however a number of critics to the new system of lease accounting. While the critics agree that there was need for making some improvements in the accounting system for lease and lease agreements, the process needed to be slow and delayed to enable the companies, and business organizations to adapt suitably to the new system of regulations.

It is expected that the new rules and regulations for lease accounting should be effective from 2017 to give companies time to comply and, in some cases, to renegotiate loan agreements so that the companies are in a better position to negotiate limitations of loans.

Under the new system, income statements for many companies would also undergo changes apart from making balance sheets larger. For example, if a company leased a piece...

Under the new system, a larger expense in early years would have to be showed by the company against the leased machinery and subsequently smaller ones in later years. This is because the new system of accounting considers the lease expenditures to be similar in nature of the company had taken a loan or borrowed money from the market to purchase and asset and would have to pay off the loan in equal sums of money over a period of five years. In the earlier formats the interest expense would be higher than in later ones (Bauman and Francis).
The accounting of lease and lease agreements in the case of real estate would be a little different. Even as leases would be put in the balance sheets as assets the value of the lease would be based on the expected lease payments over the entire period of the lease. This rules out the considerations for renewal and the costs and prices involved in it unless it is assumed that the renewal would be at such favorable prices that it would act as a significant financial incentive to renew.

In the cases of any variable basis for the calculations of the lease payment, the value would not reflect the expected additional payments as is with the case of a store lease that has two components, the lease amount and a percentage of sales. This would help in keeping the value of the asset as well as the related debt at a lower scale than otherwise (Cheng).

The Advantages of the new system

The new system would help in determining the Lease Term accurately.

The longest possible term for a lease that is more likely than not to occur is defined by the proposed new standard for accounting of lease and lease agreements. This also considers the effect that can emanate from the options for the extension or termination of the lease and the lease agreement.

There are possibilities that leases could entail several clauses that can include unfavorable renewal options, penalties for early termination of the lease agreement and a combination of a renewal option and a residual value guarantee. There uncertainties are taken care of in the proposed new accounting standards for lease.

The lease agreement or the contract, for examples, may have options of the leased asset to be renewed and the user continues using the asset or returning the asset back to the owner at the end of the original lease term.

In such contracts there can be, as is often the case, that the lessee pay the lessor the difference between the expected residual value and the actual residual value in case the lessee decides to hand over the asset to the lessor at the end of the contract period.

The new format allows taking into account the assessment by the lessee and lessor at inception of the lease agreement whether it is more likely than not that the lessee and the lessor would agree to the extension of the contract at the end of the contract period.

Estimation of a probability of occurrence for each possible lease term -- in cases of the leases renewal, early termination of the contract or a combination of renewal and residual value guarantees, and a calculation needs to be made about the expected outcome to derive from the use of the asset during the ease term and the discount of the future lease payments.

The assessment and the reassessment of this aspect requires to take in to consideration the expected outcome that is more likely than not to occur at each reporting date where assumptions are based in any new facts or circumstances that can indicate any significant change in the earlier assumptions.

The new proposal makes possible the following considerations in the making of assessment of the probability for each of the possible end of lease term options.

The level of lease payments, bargaining for renewal options, penalties for termination of the contract and the contingent rental payments are taking into account as part of the contractual factors. The influence of the local regulations, costs for relocation of the leased asset and any significant improvement in the existing leasehold and such non-contractual factors are taken into account in the new accounting system (Bauman and Francis).

The significance of the impact on the lessee's operations by the underlying asset and whether the asset has a specialized value for the lessee are business aspects that are taken into account and are reflected in the balance sheet while determination of the lease term. Other aspects that…