Changes to Lease Accounting: Rules, Reactions and Realities
Executive Summary:
The Exposure Draft (ED) addresses both lessee and lessor accounting but excludes transactions that are considered in-substance purchases. There are no exclusions for small-ticket leases or noncore assets, however. Lessees must capitalize all leases at the present value of the payments, based on estimates of the most likely term and contingent rents.
This capitalization will impact lessee financial statements and performance metrics, resulting in a decline in leasing for those customers that focus solely on off balance sheet financing. The requirement to assess the most likely lease term could result in additional declines in volume, although lessee responses to this rule indicate otherwise, meaning that lessors must continue to emphasize the many other benefits of leasing. Lessors must educate their sales forces on the accounting changes so they can answer questions, address customer concerns, and identify opportunities, such as those for lessees that emphasize EBITDA.
The lessor accounting products of FAS 13 are replaced by performance obligation leases and derecognition leases. The distinction between the two leases is based on whether the lessor retains exposure to significant risks or benefits in the leased asset. Lease income under the new rules is either more uneven, volatile, front-loaded, or back-loaded than under the current rules, depending on the lease type and transaction. This economic/accounting divergence is evident not only in income recognition, but also in other areas, such as residual management. Residual accretion is no longer allowed, but sales-type revenue recognition is available in derecognition leases.
The operational burden faced by lessors increases under the proposed rules, emphasizing the importance of the lessor’s software applications and associated vendor support. New capabilities also will have to be created and integrated. In this regard, lessors will have to determine whether the enhancements required by the new rules represent system maintenance, or if they are additional costs.
Since the proposed changes require estimates and interpretations to book the lease, the lessor’s ability to utilize workflows, flexible configuration, and rules engines will be an important element of conforming the lease management system to the new rules. Lessors will need to maintain open communications and dialogue with their lease system providers in order to avoid these problems.
The proposed changes are not the knockout punch that many expected, as lessees will continue to focus on the many other benefits of leasing. Lessors will have to act proactively, however, if they are to remain competitive in the new environment.
Table of Contents:
- 1 Executive Summary
- 2 Project background
- 2 Past Lease Accounting
- 3 The Lease Accounting Project
- 4 Exposure Draft elements
- 4 Scope
- 6 Lessees
- 11 Lessors
- 21 Transition
- 22 Disclosure
- 24 Market impact
- 24 Lessees
- 24 Off balance sheet financing
- 29 Increased effort
- 30 Other consequences
- 30 Lessors
- 30 Market response
- 32 Implementation
- 34 Transition
- 39 Service providers
- 42 Conclusions
- 43 Appendices
- 44 Appendix One – Tables and Figures
- 45 Appendix Two – Study Methodology
- 47 Appendix Three – Lessee Survey
- 49 Appendix Four – Lessor Survey
- 52 Appendix Five – Software Provider Survey
- 54 Researchers
- 57 Endnotes
