The Future of Leases
By: Gardiner Thomsen CPAs | email
Back in 2006, the Financial Accounting Standards Board (FASB) formally announced that it would reconsider the accounting for leases, and as we enter the second quarter of 2010, they are preparing to release a preliminary standard. Although the final rules and changes are not anticipated to be finalized for another year or two, you can expect some significant changes on how you will need to begin accounting for your lease agreements in the future.
In the past, Companies have been able to designate their lease agreements as either operating or capital. Accounting for operating leases has always been straightforward as payments made are charged to rent or lease expense. Known as a form of off-balance sheet financing, operating lease obligations are not recorded in the financial statements but rather disclosed in the footnotes. However, if lease agreements meet certain criteria, they are essentially treated as financing arrangements known as capital leases. Capital leases require the recording of the leased asset and the related lease liability on the balance sheet with future payments made on the lease reducing the liability rather than being charged to expense. So instead of rent or lease expense impacting your income statement, depreciation expense and interest on the recorded liability would take its place.
What the FASB is proposing is that the accounting for operating leases will be eliminated and all lease agreements will follow the capital lease model. Whether the lease is a one year agreement for a vehicle or a ten year agreement for property, these leases will find their way to your balance sheet. Although it is unclear on how preexisting leases will be treated once this standard comes into effect, what is obvious is that certain ratios and financial figures used by lenders and regulatory bodies will change as a result of this future standard. Yet as this is a change in accounting standard, you should expect that these groups will adjust their covenants required of you accordingly.
We will continue to watch the development of this issue, but if you have any questions, please feel free to contact us.
