On February 25, 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) intended to improve financial reporting about leasing transactions. The ASU affects all companies and other organizations that lease assets such as real estate, airplanes, and manufacturing equipment.
Under the current accounting model, an organization applies a classification test to determine the accounting for the lease arrangement:
- Some leases are classified as capital leases (for example, a lease of equipment for nearly all of its useful life) whereby the lessee would recognize lease assets and liabilities on the balance sheet.
- Other leases are classified as operating leases (for example, a lease of office space for 10 years) whereby the lessee would not recognize lease assets or liabilities on the balance sheet.
The existing operating lease model has been criticized for failing to meet the needs of users of financial statements because it does not always provide a faithful representation of leasing transactions.
The U.S. Securities and Exchange Commission (SEC) issued a report on off-balance sheet activities in 2005 that recommended that changes be made to the existing lease accounting requirements to ensure greater transparency in financial reporting. A number of other studies have made similar recommendations.
In 2006, the FASB and the International Accounting Standards Board (IASB) embarked on a joint project to improve the financial reporting of leasing activities.
The new guidance responds to requests from investors and other financial statement users for a more faithful representation of an organization’s leasing activities.
The new guidance responds to requests from investors and other financial statement users for a more faithful representation of an organization’s leasing activities. More details on the FASB’s outreach to stakeholders during the project can be found within a FASB In Focus document and a feature video, Why a New Leases Standard?
The new guidance ends what the SEC and other stakeholders have identified as one of the largest forms of off-balance sheet accounting, while requiring more disclosures related to leasing transactions.
The guidance also reflects the input the FASB received during its extensive outreach with preparers, auditors, and other practitioners, whose feedback was instrumental in helping the FASB develop a cost-effective, operational standard.
For access to a short video to explain FASB new standards click here