The Financial Accounting Standards Board (FASB) and its international equivalent, the International Accounting Standards Board (IASB), are close to finalizing major changes to the financial accounting standards for leases that would require the capitalization of nearly all real estate and equipment leases on balance sheets by recognizing the rights and obligations of tenants. On August 17, 2010, FASB and IASB (collectively, the “Boards”) released a draft proposal, known as an Exposure Draft, of the new lease accounting standards. Although the Exposure Draft was open for public comment until December 15, 2010, commentators have noted that it is unlikely that the key elements of the draft will change.

Since December, FASB and IASB have undertaken various public outreach activities to discuss the proposals with a wide range of interested parties. The Boards held public roundtable meetings around the globe during December 2010 and January 2011 to discuss their Exposure Draft with key stakeholders. FASB’s stated purpose in holding these meetings was to “engage in a constructive dialogue about the Exposure Draft with a wide variety of stakeholders, representing a variety of perspectives, including those of preparers, auditors, investors, and other users of financial statements.” In addition to the public roundtable meetings, FASB has made webcast discussions available on its web site and held a Leases Working Group Meeting on January 7, 2011, in Norwalk, CT, to continue the discussion process.

After the public discourse and deliberations have concluded, the Boards have announced that they will revisit all feedback, deliberate significant issues and issue a final lease accounting standard sometime around June 2011. The Boards have not announced a date for the issuance of the final revised standard, but FASB has indicated, and it is generally expected, that the final standard will be issued during the second quarter of 2011.

If adopted, the new accounting rules would require almost all leases to be capitalized on a tenant’s balance sheet. Under current International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP), leases that are classified as “capital” or “finance” leases are accounted for as a sale and included on the tenant’s balance sheet. Leases classified as “operating” leases are not recorded as assets or liabilities on a tenant’s balance sheet. These models have been criticized for failing to provide a faithful representation of leasing transactions, as they omit relevant information about rights and obligations that would otherwise meet the definitions of “assets” and “liabilities.”

The Exposure Draft generally maintains the positions released by FASB in its preliminary statement of May 2009 and establishes a single method of lease accounting that would require tenants to list nearly all leases on their balance sheet as a “right of use” asset and as a corresponding “future lease payment” liability. In addition, tenants would be required to document the lease value or rent obligation over the entire lease term, including renewal options. Tenants most affected are those with a significant portfolio of assets held under operating leases. Currently, US GAAP and IFRS account for lease payments arising from operating leases by recognizing them in the period in which they occur.

Placing the entire lease obligation on the balance sheet, resulting in a negative pull on corporate earnings, will dramatically affect companies’ perceived financial performance. The long-term effects of this change in lease accounting are still unknown. Many industry experts are predicting that companies will seek short-term leases or favor ownership over leasing, to avoid the consequences of this new accounting methodology. In addition, we are advising companies facing the challenge of meeting these new requirements to assess the appropriateness of their existing lease administration systems and to make sure that their administration systems will accommodate the new accounting requirements.