In August 2010, FASB (Financial Accounting Standards Board) and IASB (International Accounting Standards Board) released a joint exposure draft that would dramatically change lease accounting for both lessees and lessors by requiring all leases to be recognized on the balance sheet. Current standards allow leases classified as “operating” to be expensed as lease payments are made with no effect on the company’s balance sheet. The proposed change would eliminate operating leases and require substantially all leases to be recorded on the balance sheet as financings.

This change could have a significant effect on your company’s loan covenants, financing agreements and regulatory requirements. Below are a few of the key effects on the financial statements of lessees that would result from this change: 

  • Assets and liabilities on the balance sheet would increase
  • Expense would be presented on the income statement as interest and amortization expense instead of rent
  • Timing of expense recognition would be greater in early years and less in later years
  • Cash flows from operating activities, as presented on the statement of cash flows, would improve, but overall cash flow would remain unchanged
    • Leverage and capital ratios would worsen
    • EBITDA (earnings before interest, taxes, depreciation, and amortization) would improve

The final standard is expected to be issued in 2011 with an effective date of 2013 or later. If you have questions on how this proposed standard might affect your company and its financial position, please contact Chortek LLP.