End of Operating Leases? Watch for Lease Accounting Changes

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The Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) are proposing dramatic changes to lease accounting rules that would virtually eliminate operating lease accounting treatment. The changes would affect all companies that lease real estate, and their company balance sheets, as a result of how leases would be classified under the proposed new rules as a capital lease transaction. One of the goals of the proposed revisions is to improve transparency in the financial reporting of lease transactions.

Under current FASB lease accounting rules, tenants are required to classify their leases as either capital leases or operating leases. The vast majority of leases are treated as operating leases. Under operating leases, the lease payments are considered a rental expense and there is no asset or liability recognized on the balance sheet. Capital leases, on the other hand, treat the tenant more like the owner of the leased property and the lease as a means to finance the acquisition of the leased property. Consequently, lease payments are treated as a liability over the term of the lease and the right to use the leased property as an asset.

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