July 19th, 2011, By Dana Haugh
So you made it through Part One and were curious enough to move on to Part Two? I commend your bravery. In this article, I’ll continue outlining the expected changes FASB is working on implementing. This will include modifications in: lessee profit and loss pattern, purchase options, variable payments, residual guarantees, short term leases, and contract modifications. Take a deep breath . . .
Lessee profit and loss patterns will be modified, most notably in that a lessee’s cost pattern will need to be front-ended. On top of that, you must amortize the right of use asset and imputed interest rate at the incremental borrowing rate on capitalized lease obligations. Pheww. Basically, changes in this area are all going to affect businesses pretty negatively. Costs will never level off, huge deferred tax assets, etc. Not good news.
As far as purchase options go, the lessee’s liability to make lease payments will include the price of purchase option and the lessor’s have the right to receive payments only when there is significant economic incentive to exercise purchase options. The changes for variable payments are a little lengthy, so get ready. Variable payments will be included in lease payments and will be capitalized by the lessee, though the specific variable payment will be limited. Variable lease payments that rely on an index or rate will be estimated and booked using the spot rate. Payments that depend solely on usage or lessee performance will not be capitalized unless deemed as disguised minimum payments. Also, complete disclosure of contingent rent leasing arrangements will be required.
Which brings me to the subject of contract modifications or changes in circumstances. From now on, any change to the existing contract must result in an entirely new contract, with the original lease recorded as closed. A change in circumstances that affects the assessment of whether a contract is or contains a lease will result in a reassessment. But, if circumstances change and it affects whether a lease transfers all of the risks and rewards incidental to ownership of the underlying asset, it will not result in a reassessment or change in the accounting approach.
Short-term leases will be defined as 12 months or less. FASB is also considering the process of expanded disclosures- lessees will essentially have to complete a process similar to ROU (right of use) accounting.
And the last topic (in this article) is residual guarantees. Residual guarantees should be reassessed when the events or circumstances indicate significant changes in the amount expected to pay under the residual value guarantee. Any changes in estimates of the residual value guarantee should be recognized in the net income to the extent that those changes relate to current or prior periods. Lessees should only record the likely payment under a residual guarantee and 3rd party residual guarantees should not be considered a minimum lease payment for the lessor.
Sigh. There’s still so much more. If you dare, Part Three.
All information gathered from FASB and Leasing 101