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Lease Accounting Financial
History and Future of Lease Accounting for Lessees
The financial community describes the changes that could arise from the FASB and IASB as an effort to bring transparency to company balance sheets. This is a continuing reaction to Enron and certain happenings earlier in the decade that brought off-balance sheet items to the forefront. There is a lot of focus on off-balance sheet obligations now. Users of financial information rely on amounts reported in financial statements to analyze relationships having the kind of predictive and feedback value that the FASB's conceptual framework attributes to decision-useful accounting information.
Standard Setting Bodies
Security and Exchange Commission
The Security and Exchange Commission (SEC) was established in 1933 after the Crash of 1930. Prior to this time there, no standard setting body existed. Even after its formation, the SEC encouraged the private sector to set them. In 1934, the SEC received the authority to establish financial accounting and reporting for publicly held companies.
Committee on Accounting Procedures
In 1939, the SEC suggested that the American Institute of Certified Public Accountants (AICPA) create a formal standard setting body. The AICPA established the Committee on Accounting Procedures (CAP). During its reign from 1939 to 1959, they issued 51 Accounting Research Bulletins. CAP was not as successful as had been hoped. CAP only issued standards on problems as they occurred. These standards are known as Accounting Research Bulletins or ARBs.
Accounting Principles Board
The Committee on Accounting Procedures was replaced with the Accounting Principles Board (APB) in 1959. They issued 31 opinions and 4 statements over the next 14 years. They are credited with the development of Generally Accepted Accounting Principles (GAAP) from the opinions and statements they issued.
Financial Accounting Standards Board
The APB was replaced by the Financial Accounting Standards Board (FASB), which was formed in 1973. FASB is an independent board with full-time members who no longer work in private firms or their employers. FASB establishes standards for accountinges in the private sector. “Standards are essential to the efficient functioning of the economy because investors, creditors, auditors, and others rely on credible, transparent, and comparable information.”
The missions of the FASB are to keep standards current to reflect any changes in methods of doing accounting, to improve the usefulness of financial reporting by focusing on relevance, reliability, comparability, and consistency, and to promote the international convergence of accounting standards.
International Accounting Standards Board
The International Accounting Standards Board (IASB) established in 2001 is based in London. It succeeded the International Accounting Standards Committee (IASC), which was founded in 1973. The IASB develops a solitary set of global accounting standards that provide transparent and comparable information in financial statements. The IASB works with national accounting standards bodies to accomplish a united set of accounting standards to be used around the world.
Original Standards for Leases
ARB 43, Chapter 14
In 1949, the Committee on Accounting Procedures issued ARB 43, Restatement and Revision of Accounting Research Bulletins, Chapter 14 Disclosure of Long-Term Leases in Financial Statements of Lessees. ARB 43, Chapter 14 only provides guidance for leasing land and buildings. The lessee assumes all the expenses and obligations of ownership, such as taxes, insurance, and repairs.
These types of arrangements differed from conventional long-term leases but the principles of disclosure were intended to be applied to both types of arrangements. The disclosures that need to be reported included the amount of annual rent to be paid, the period for which the payments are payable. The disclosure is to be reported for the life of the lease not just the first year. In the first year of the lease, the disclosure needs to detail the transaction.
APB Opinion No. 5
The Accounting Principles Board issued Opinion No. 5, Reporting of Leases in Financial Statements of Lessees in September 1964 and supercedes ARB 43, Chapter 14. Since ARB 43 had been issued, leases had been disclosed on financial statements but not in a consistent manner. The information disclosed was often not enough for investors to get a clear picture of a company’s financial position.
According to APB Opinion No. 5, there had been very few instances of capitalization of leased property and recognition of the related obligation. In the Accounting Principles Boards opinion, rental (lease) payments for services, property taxes, utilities, maintenance, etc. are to be treated as an expense. Having the right to use property and paying a specific rental amount over a period are not considered an asset or liability.
An operating lease should disclose pertinent information about the lease or rental agreement and the information disclosed will vary from one situation to another. Lessees were to disclose the minimum annual payments and length of time at the least. The maximum they should disclose was the type of property leased, the obligation assumed, requirements of the lease
Lease arrangements that are similar to an installment purchase should be listed on the balance sheet and depreciated accordingly. For a lease agreement to be capitalized there should be material equity in the purchase. APB No. 5 states a capitalized lease may require a note or schedule to disclose the details of the lease agreement.
The International Accounting Standards Board (IASB) issued IAS 17, Accounting for Leases, in September 1982. A lease is classified as a finance lease or operating lease. A finance lease is classified as such if it transfers substantially all the risks and rewards to the lessee. All other leases are classified as an operating lease.
The following situations would lead a lease to be classified as a finance lease:
- Transfer of ownership of the asset to the lessee at the end of the lease
- The lessee has the option to purchase the asset at an amount that is sufficiently lower than the fair value
- The lease term is for most of the assets life
- At the beginning of the lease, the present value of the minimum lease payments is equal to the fair value of the asset.
The IASB requires that the following accounting principles be applied to finance leases. The finance lease should be recorded as an asset and a liability at the lower of the fair value of the asses and the present value of the minimum lease payments, lease payments are to be apportioned between finance charges and the reduction of the principle outstanding liability, depreciation should be consistent with that of other owned assets
Lessees of finance leases disclose the carrying amount of the asset, reconciliation between total minimum lease payments and the present value, amounts of minimum lease payments as of the balance sheet date, and the present value for the next years, years 2 through 5 combined, and beyond 5 years and a general description of the lease arrangement.
Lessees of operating leases recognize the lease payments as an expense on the income statement. They should provide in the financial statement disclosure a description of the lease arrangement, including any provisions, whether there is a purchase option, and any restrictions that are imposed. Also, lease payments as of the financial statement date for the next year, years 2 through 5 combined, and beyond 5 years.
Changes to Original Standards
APB Opinion No. 31
The Accounting Principles Board issued Opinion No. 31, Disclosure of Lease Commitments by Lessees, on June 1972 with an effective date of January 1, 1974. Opinion No. 31 was developed because investors, grantors, and users of financial statements acknowledged that at the time the disclosures did not provide all the information they deemed important.
The APB issued it to clarify and now require the disclosure requirements of APB Opinion No. 5. The Board did not want to establish any disclosure requirements because the FASB had placed leases as a subject on its agenda at the time this was issued. The Board was hesitant because they did not want to bias the decision.
The Board reworded its requirements for the disclosures of operating leases. A lease that is for one year or more needs to provide the total rental expense. The minimum rental payments should be disclosed for each of the five succeeding years, each of the next three to five year periods, and the remainder should be listed as a single amount.
Additional disclosures that should be included are whether the payments are dependent upon any factors other than time, if so what is the basis for calculating the payments, is there a purchase or renewal option, and any restrictions.