By Shane E. Brown
The initial FASB exposure draft on lease accounting was released on August 17, 2010, and many in the construction industry took the opportunity to comment on the exposure draft from its release date until December 15, 2010. The comment period was successful in pointing out ambiguities, problems, and potential costs resulting from this exposure draft.
Given the issues communicated by various stakeholders, FASB decided in July 2011 to re-expose the revised proposals. The re-exposure date is expected to be in the first half of 2012. Re-exposing these proposed changes is intended to clarify the original draft language and simplify implementation of the revised lease standard.
During 2011 board meetings, FASB tentatively decided on the following changes to the exposure draft:
- Capital leases currently recorded on the balance sheet will not be remeasured at the fair value of remaining payments. Instead, these capital leased assets and liabilities will be transferred to a right-to-use asset and liability at their respective carrying values.
- Operating leases not currently recorded on the balance sheet will have an asset and liability measured at the present value of remaining lease payments using the borrower’s incremental borrowing rate. The right to use asset and liability values will be adjusted for any remaining deferred rent liability or prepaid rent assets.
- Lessees will not re-evaluate initial direct lease costs for leases existing at date of transition.
- Disclosures at transition will essentially be the same. Changes in estimates and errors are required. However, there will not be a need to disclose changes to income or any other line item as a result of the transition, including any prior periods retrospectively adjusted.
- Short-term leases, defined as having a maximum possible term of 12 months or shorter in duration (including renewal options), are excluded from capitalization requirements.
However, the following concerns remain for the construction industry:
- The construction industry has expressed the desire to define short-term leases as the company’s operating cycle. This would match the economic substance of certain leases with related long-term construction contracts.
- The lessee will evaluate renewal periods, such as optional renewal periods, to determine if there is enough economic incentive to exercise the option. This decision is largely a judgment call.
- As discussed in “Lease Accounting Update for Contractors” (link to http://www.cfma.org/bp_online) from the November/December 2010 issue of CFMA Building Profits, bonding ratios will be significantly affected. The capitalization of operating leases leads to negative impacts on debt service coverage, working capital ratios, and positive impacts on EBITDA.
- Also mentioned in the article, current Federal Acquisition Regulations (FARs) disallow interest expenditures from being reimbursed, while rent expense is typically reimbursable. The new lease standards are likely to have a negative impact on government contractors by reducing reimbursable expenditures.
The effective date of a final lease standard is currently undetermined.
Note: This article is an update to “Lease Accounting Update for Contractors” from the November/December 2010 issue of CFMA Building Profits.
Shane E. Brown, CPA, CCIFP, is a Partner in the audit service area of EKS&H, an accounting firm in Denver, CO, where he leads the construction services group. He can be reached at 303-740-9400 or sbrown@eksh.com.