The IASB is proposing to replace its existing model for lease accounting, by removing the distinction between operating and finance leases and replacing the current ‘risks and rewards’ principal with a ‘right-of-use’ concept. The result is expected to be that all leases for more than 12 months will end up on lessees’ balance sheets, by recognizing an asset and liability at inception of the lease.
If the proposed guidance is implemented, the effects would be balance sheets growth, increased leverage ratios, and decreased capital ratios. Income statement recognition will differ between Type A and Type B leases. Most real estate leases will be type B leases requiring a straight line income recognition pattern. Most non-real estate leases will be Type A leases requiring an income recognition pattern similar to a financing arrangement. Hence, for Type A leases, there would be a change to both the expense character (rent replaced with depreciation and interest expense) and recognition pattern (significant acceleration of total expense recognition relative to recognition pattern under current rules) associated with the lease, causing performance measures (e.g. EBIT, EBITDA etc.) to change.