Map Your Business Strategy Now for Implementing New Lease Accounting Standard

leasing transactions standard

Given the complexity of leasing transactions and their prevalent use by all types of businesses, from public to not-for-profit, and all types of industries from banking to healthcare, developing a standard that meets the needs of financial statement users and does not create too cumbersome a burden for businesses has proven to be a challenging undertaking for the Financial Accounting Standards Board (FASB).  However, the wait is finally over.  On February 25, 2016, the FASB issued its highly anticipated Accounting Standards Update (ASU) for leases: ASU No. 2016-02 – Leases (Topic 842).

The FASB, originally in conjunction with the International Accounting Standards Board, has spent years working to revise its existing accounting guidance for leases.   The objective was simple: to increase the clarity of financial statements by allowing the users of those statements to more easily identify the financial obligations of businesses, specifically as it relates to the accounting for leases.  A common complaint of users of financial statements is that the existing accounting model for leases does not always provide full transparency and faithful representation of a business’s leasing arrangements and transactions.

This new guidance aims to address those concerns.  Some of the main provisions of the new standard for lessees are as follows:

  • Leases are to be categorized as financing or operating.
  • Lease arrangements will be recognized on the balance sheet as a right-of-use asset and lease liability unless the lessee elects, through an accounting policy change allowed under the new standard, to exclude leases with terms that are less than or equal to 12 months.
  • Similar to the treatment of operating leases prior to the new standard, operating leases will be recognized in the income statement as a single straight-line lease expense which will include the interest expense of the lease liability and the amortization of the right-of-use asset. This single line item is to be recognized as an operating expense.
  • For financing leases, the amortization of the right-of-use asset and the interest expense associated with the lease liability are not required to be presented in a single line item and are to be presented in the income statement in a manner similar to the presentation of an entity’s other interest and depreciation expense.

Public entities and not-for-profit entities with outstanding bond debt are required to adopt for fiscal years beginning after December 15, 2018, (meaning January 1, 2019, for those on a calendar year).  All other entities have an extra year, as they are required to adopt for fiscal years beginning after December 15, 2019, (meaning January 1, 2020, for those on a calendar year).  Early adoption is permitted for all entities.

This accounting standard is to be adopted through a modified retrospective approach which requires that leases be recognized and measured at the beginning of the earliest period presented.  This modified retrospective approach includes practical expedients which, in essence, allow an entity to account for leases based on the previous leasing model if they commence prior to the effective date of adoption.  One exception is that a right-of-use asset and lease liability would be added to the balance sheet for all operating leases, as of each reporting date, based on the present value of the remaining lease payments.  Although the required adoption of this guidance is years away, the time to prepare is now.  For entities that present comparative financial statements and are required to adopt for fiscal years beginning after December 15, 2018, leases will need to be recognized and measured as early as January 1, 2018.

Changes to existing control structures, systems, and business processes may need to be implemented in order to completely and accurately capture the data necessary to ensure a smooth transition to the new guidance.  This new standard undoubtedly has the potential to impact a business’s debt covenants, lease-versus-purchase decisions, and beyond.  Learning and understanding this new standard now can effectively position your business to make sound decisions for the future.  Thus, there is never a better time than today to equip your business for this impending change.

In the near future, PYA will be issuing a white paper which covers in greater detail the changes included in this new standard and how it will affect your business. This white paper may be used as a resource as your business transitions to the new lease accounting.

If you have questions about this new standard or what it means for your business, or would like to request a speaker on this topic for your organization or event, contact one of our executives listed below, (800) 270-9629.


Doug Arnold

Doug Arnold

Principal

Matt Neilson

Matt Neilson

Director of Financial Reporting

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