The Financial Accounting Standards Board approved a new rule for companies leasing out assets in an effort to eliminate a sometimes sizable accounting loss at the start of certain contracts.

The new standard, approved Wednesday by the U.S. accounting standard-setter, serves as an update to a rule that went into effect for public companies in early 2019 and requires businesses to put operating leases on their balance sheets instead of in footnote disclosures.

Under current accounting rules, lessors have to recognize a loss at the beginning of certain types of leases even if they expect the arrangement to be profitable overall. The requirement was an unintended consequence of past rule alterations, FASB board members said. The rule applies to so-called sales-type and direct-financing lease arrangements involving payments that can change depending on circumstances such as customers’ usage of equipment or property.

For example, electric companies charge customers based on their electricity usage. Office-equipment and medical-device companies often rely on contracts with future payments that fluctuate in size, for example for using printers or magnetic resonance imaging machines, respectively.

The recorded loss does not reflect an actual loss related to the contract the lessor signed, an issue companies may have to explain to analysts or investors, the FASB said. In cases in which the lessor’s contract includes highly variable future payments, the size of the accounting loss could be substantial.

“This accounting doesn’t reflect the reality of the transaction,” board member Gary Buesser said. He added that companies don’t enter agreements “expecting a loss.”

Under the new standard, lessors are no longer required to recognize the accounting loss in those contracts. The benefits of a more accurate presentation of the lease arrangement justify additional costs to implement the changes, the FASB staff said.

Alphabet Inc.,

which owns Google, among other companies, supported the proposal. Alphabet’s net property and equipment, which includes assets in sales-type leases and other finance leases, totaled $84.75 billion in 2020, up 15% from the previous year, the company reported in February.

Removing the loss requirement would more closely align the FASB with international accounting standards without creating additional operational challenges for companies, Gabor Turschl, the company’s director of technical accounting, wrote in a Dec. 8 letter to the FASB. Alphabet didn’t immediately respond to a request for comment on Wednesday.

The rule change is set to take effect for both public and private companies in fiscal years that begin after Dec. 15, 2021. Companies are permitted to adopt it early, but only if they have already implemented the broader lease-accounting changes. Some private companies have yet to adopt those changes.

The FASB in February decided to pare down its initial October proposal on leases. That proposal for example would have allowed companies leasing assets to recalculate lease liabilities depending on changes in the consumer price index or another economic indicator that affects future lease payments. The FASB said it removed that aspect of the proposal because the change would have gone into effect too late to be useful for companies.

Write to Mark Maurer at [email protected]

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