The Financial Accounting Standards Board (FASB) issued a proposal in August that could dramatically change the nature of accounting for operating leases.
“It’s part of an effort to conform U.S. accounting standards to international rules,” says James C. Suttie, CPA/ABV, CVA, a principal with Skoda Minotti. “And it is in response to criticism that U.S. accounting doesn’t currently record a liability for operating lease obligations, although a company could be obligated to fulfill a lease for the next few years. If it is an operating lease, there is currently no asset or liability recorded on the balance sheet under U.S. accounting rules.”
Smart Business spoke with Suttie about the new proposal and how it will affect businesses with operating leases.
What is the reason for this new proposal?
There has been a push over the last several years to standardize things on a worldwide basis. If you look at international accounting standards, the thought is, ‘We do it this way in Europe, but if we do it a different way in the U.S., it can cause confusion.’
The impact on small businesses can be an undue burden, not just with this proposal, but when an effort is made to standardize things across the board for both privately-held and publicly-traded companies. They live in two different accounting universes, so to speak. So what’s good for the goose is not always good for the gander. With that said, you still have to follow the rules.
How will this affect accounting for operating leases?
There are going to be a couple of significant changes if and when this is enacted. Leases would be recorded as a depreciable, “right-to-use” asset on the balance sheet with an equal offsetting liability. There is also going to be a front-loading of expense, similar to the way a mortgage works. With mortgages, you pay more interest early on and then, the interest expense decreases as the loan draws to its conclusion. Leases would work in a similar fashion, and the principal obligation of the lease liability would be paid down slowly as the term of the lease matures.
Are existing leases exempt?
No. The proposal will affect all leases. So, for example, if you have a current operating lease that you have had for two years and there are still three years remaining on the lease, you would have to record the lease as an asset at the net present value of the remaining term at that point.