Proposed changes to the IASB/FASB lease accounting rules create the need for financial and real estate executives to develop a plan of action that ensures their organization's readiness. Download this white paper to understand how these changes create a need for new processes and systems to achieve compliance and drive the need for new and broader skills within financial and real estate personnel.
IBM Software July 2011Thought Leadership White Paper
Action plan to prepare for the
New Lease Accounting Standard
William Bosco, President, Leasing 101
ContentsThe International Accounting Standards Board ("IASB") and the Financial Accounting Standards Board ("FASB") -2 Timing of the project accounting standards boards for the U.S., Europe and many2 What is the project? other countries-are jointly working on a replacement for thecurrent lease accounting standards, IAS 17 and FAS 13, that3 What is the impact? will be followed by publicly traded companies worldwide. The3 Financial impact impetus to this new standard was the ENRON accountingscandal of 2001. ENRON's demise was not caused by leases5 Operational impact but it was caused by other off-balance sheet transactions.These transactions proved to be accounted for incorrectly and5 Recommended action plans readers of ENRON's ?nancials were not totally aware of their7 Transition project implications. The crisis prompted the U.S. Congress to enactthe Sarbanes Oxley Act which, among other things, directed7 Ongoing project the U.S. Securities and Exchange Commission ("SEC") 8 Review leasing business policies to identify other off-balance sheet transactions. Leases, speci?cally operating leases, were cited as a major class of 9 Monitor the project off-balance sheet obligations. In the opinion of the SEC, 9 Real estate lease administration process checklist readers of ?nancial statements would have better informationif operating leases were capitalized as an asset and a liability 10 IBM and TRIRIGA on balance sheet. As a result, the IASB/FASB put a leaseaccounting project on their agenda in 2006 with an objectiveto create a new lease accounting standard that requires lesseesto capitalize an asset and liability for all operating leases.2 Action plan to prepare for the New Lease Accounting Standard
Timing of the project What is the project?The Lease Project is progressing with a target completion The focus of this white paper is lessee accounting, leasedate of year-end 2011 or early 2012 depending on whether administration and operational impacts. For lessees the projecta new Exposure Draft is issued for public comment. An means a complete change from current standards IAS 17 andExposure Draft ("ED"), published in mid-August 2010 and FAS 13. Under current FAS 13 rules, operating leases werereviewed over the subsequent four months, provided a draft off-balance sheet with only the straight line average rentof the ?nal proposed rules. The IASB/FASB have had subse- reported as a cost in the pro?t and loss ("P&L") statement.quent meetings through May 2011 which are re?ected in this The proposed rule will require a lessee to estimate the leasepaper. Changes will continue, so the reader should monitor term and estimate lease payments based on assumptionsthe project. The ?nal standard was due to be issued during related to contractual terms and other factors. The lessee will2011, and the effective date from which companies must com- calculate the present value ("PV") of the estimated paymentsply with it is expected to be January 2015. The transition and using the lower of the company's incremental borrowing ratecompliance requirements are complex, so companies should (the interest rate charged to borrow under a secured loan withstart to plan for the new standard immediately.
New lease accounting standard timeline
Lease accounting project event
Issue exposure End of Re-deliberation draft comment period of issues Issue final new rule Implementation
Mid-August 2010 Mid-December 2010 First Half 2011 December 2011 Likely to be 2015, but may require reporting from 2013
TransitionAll existing leases must be booked prospectively under new rules
Figure 1: New lease accounting standard timelineIBM Software 3
similar terms) or the rate implicit in the lease, if known The effect of front-ending lease costs(most often the lessee does not know the implicit rate in thelease). This PV is considered to be the value of the right to Lease term First year percentage increase in lease cost - proposed rules vs. current GAAPuse the leased asset and the "principal" balance of the obliga- 3 Years 7%tion to pay rent. This PV amount will be recorded as an asset 5 Years 11%and a liability. The asset will be amortized (like depreciation) 7 Years 16%straight line ("SL") to P&L. The lease paymen... [download for more]