The proposed accounting standard connected with accounting for leases has been the subject of controversy and criticism. The relevant leases are presently “off” the balance sheet as they can be classified as operating leases under
current accounting principles, neither an asset nor a liability.
The accounting boards have however, taken the position that leases transfer valuable rights and obligations that should be reflected “on” the balance sheet so readers have information about the obligations of a business related to its leasing activity.
In May 2013 the boards issued a new Exposure Draft (“ED”) essential following on from their original 2010 proposals, which, if it becomes effective, would materially change the accounting treatment leases. For those affected, it is important to become aware of the changes proposed and how they will modify current accounting standards.
The amount recorded would initially be the discounted present value of the lease payments required by the lease agreement. The rate used to discount the payments would be the rate that the lessor charges, if known, or the lessee’s incremental borrowing rate.
Depending on the lease term, the liability may be significant in relation to the total amounts of assets, liabilities, or net equity reported on the entity’s balance sheet. Some lessees are already discussing the effects of these potential changes to their balance sheets with lenders, as many loan agreements have financial covenants that may be impacted.
The new rules may impact the real estate business by encouraging lessees to enter into shorter-term leases in order to reduce the amount of debt on their financial statements. A move to shorter-term leases could be viewed as increased credit risk to landlords.
Although no effective date was mentioned, it is likely there will be a delay in making the new rules effective in order to give companies time to comply with the new rules and to allow them to renegotiate their loan agreements.
If you want to gain a better understanding of how you maybe affected by these changes please contact us for further information on 020 7060 6142