Lease Accounting: Lessee Provisions of the Proposed Accounting Standards Update

Lease accounting has an extremely lengthy and controversial history because it has been a major source of off-balance-sheet financing. In view of the many public outcries for increased transparency in financial reporting, it is no surprise that the accounting profession has intensified its interest in lease accounting. Given these longstanding concerns, it is remarkable that lease accounting has remained unchanged for more than a third of a century. This article briefly outlines the history of the debate and discusses the main provisions of a very significant proposed Accounting Standards Update (ASU) that has the potential to sharply curtail the current abuse of lease accounting as a means of obtaining off-balance-sheet financing. The History The problems with lease accounting are not new. In fact, the Committee on Accounting Procedure clearly identified the central problems when it issued Accounting Research Bulletin (ARB) No. 38, "Disclosure of Long-Term Leases in Financial Statements of Lessees," in 1949. (1) An effective resolution, however, has remained surprisingly elusive. Nearly 70 years have passed since that ARB was issued, yet little has changed regarding the basic premises at the heart of the debate. One of the most surprising aspects of this heated debate on leases may simply be the length of time it has taken the profession to adopt measures to resolve the problem effectively. To stem the growing occurrences of off-balance-sheet financing, in 2005 the Securities & Exchange Commission (SEC) issued its long-awaited report that called for changes in lease accounting standards. (2) In 2006, both the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) responded to these calls for action by placing the topic of lease accounting on their agendas. The primary issues of contention in ARB No. 38 in 1949 were virtually identical to the issues the IASB and the FASB later identified in their lease Exposure Drafts they released jointly in August 2010 and May 2013. (3) Likewise, the proposed solutions in these Exposure Drafts are remarkably similar to proposals in Accounting Research Study No. 4, "Reporting of Leases in Financial Statements," released in 1962 by the American Institute of Certified Public Accountants (AICPA). (4) Interestingly, the highly criticized provisions of Statement of Financial Accounting Standards (SFAS) No. 13, "Accounting for Leases," which were put in place in 1976, were meant to curb lease accounting abuses that were associated with the then-existing standards as prescribed by Accounting Principles Board (APB) Opinion No. 5, "Reporting of Leases in Financial Statements of Lessee. " (5) As was noted in 1996, it soon became clear that these provisions only served to "constrain, rather than end, the use of leases for off-balance sheet financing" as entities soon began structuring lease agreements to "fall just short of the cut-offs established by the FASB criteria. " (6) Fortunately, the Boards' efforts over the years have culminated in Proposed Accounting Standards Update--Leases (Topic 842): A Revision of the 2010 Proposed FASB Accounting Standards Update, Leases (Topic 840), which would sharply curtail the potential for further misuse of lease agreements as a source of off-balance-sheet financing. Main Provisions The most noteworthy provision of the proposed ASU is the requirement that, with some limited exceptions, all leases having a duration of more than one year are to be capitalized. Currently, companies can report long-term leases as either capital or operating leases, depending on the lease contract's specific terms. The criteria to make this determination have been increasingly criticized as "bright-line" accounting because of their precisely defined limits. The existence of these clearly delineated limits allows companies to structure leases in a manner that circumvents these specific bright lines and thus avoid recognition of the lease assets and associated lease liabilities that are inherent to capital lease arrangements. …