Accounting for leases

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Accounting for leases
Kevin Tran
DeVry University

Author Note
Kevin Tran, Keller Graduate School of Management, DeVry University

Course Note
ACCT 525 Current Issues In Accounting, Professor Achilles

August 24, 2013

This paper will provide an overview of lease accounting. It will present the history, current status, and future implications of the latest proposed standard, as jointly issued by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). Furthermore, the paper will take into account relevant observations made by various proponents who are concerned about the standard, and conclude with a personal opinion on the standard and why it’s better than the current standard.  

Existing accounting standards between the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have allowed corporations to avoid reporting assets and liabilities via “operating leases.” Thus, it has become common practice for corporations to utilize these operating leases as a source of deceptive financing—by being able to materially mislead creditors and investors due to off balance sheet accounting. Lease accounting is a classic example (or phenomenon) that shows how people tend to exploit accounting standards in order to violate the “substance over form” accounting principle (where the economic reality can be distorted from the legal reality).

The history of lease accounting is an interesting one. In 1976, FASB released Statement of Financial Accounting Standards (SFAS) No. 13 – Accounting for leases. Since then, the accounting standard allowed companies to report some leases as an asset and a liability (i.e. capital/finance leases), and other leases as a non-asset and non-liability (i.e. operating leases). However, since the FASB-IASB convergence project began (from the 2002 Norwalk Agreement), they have reached a general consensus with investors that in many instances, operating leases can be misleading and could cover up material amounts of credit risk of a given company. It is interesting to note that such an issue had already been acknowledged by the late 70s, shortly after FASB released SFAS 13 (Kieso, Warfield, & Weygandt, 2004, p.1119). The issue was momentarily brought up again during the early 90’s for resolution, but was sharply protested by corporate interests and subsequently dismissed (Norris, 2013). Only now, has there been serious reconsideration of the standard; and can demonstrate how long it can take for accounting standards to respond back to the needs of financial statement users.

On June 16, 2005, the US Securities and Exchange Commission (SEC), in response to the Sarbanes-Oxley Act (SOX) of 2002, publically released “On Arrangements with Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filings by Issuers.” This public statement proposed several important goals and recommendations, among them a proposal to improve accounting for leases. By July 2006, the FASB and IASB established a Work Plan, in order to improve the standard for lease accounting ("Work Plan for IFRS – Leases," 2013). The project has yet to be completed. Details about its current status will be described next.

On May 16, 2013, FASB-IASB has released their latest exposure draft on accounting for leases. Based on user feedback, this draft arose from earlier draft iterations that were released in March 2009 and August 2010 ("Exposure Draft," 2013, p. 1). If approved, the draft would supersede IFRS IAS 17 and FASB Topic 840 ("Exposure Draft," 2013, p. 2). As a result of this draft, FASB-IASB will also attempt to concurrently update revenue recognition standards accordingly, as the latest proposal intends to make sure the accounting for revenues and expenses for both the lessor and lessee will be consistent with each other ("Exposure Draft," 2013, p. 1). Furthermore, there are still some minor...
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