Grant Bennett Associates: AICPA

FASB Issues Lease Standard

In February 2016, the FASB issued its much-discussed and controversial guidance on accounting for leases, ASU 2016-02, Leases (Topic 842). As you probably know, the major thrust of this guidance will be the recognition of additional lease assets and lease liabilities on the balance sheet, as well as new disclosures about the entity's leasing arrangements.

Why Was the ASU Issued?

As we all know, leasing transactions are extremely common at many entities. Current accounting for leases, especially for those deemed to be operating leases of lessees, has been criticized for decades as failing to adequately portray an entity's obligations, as well as the associated rights, under leasing transactions on the balance sheet. While the notes to the financial statements have provided information on such leases, many decision makers felt that the financial statements were not sufficiently transparent regarding such assets and liabilities, which also hindered comparability among organizations.

As a result, the new guidance primarily addresses these shortfalls in lessee accounting. For the most part, existing lessor accounting is largely unchanged by the new ASU. However, certain changes in lessor accounting have been made to conform and align it to the new lessee accounting and other areas of GAAP.

What's Changing?

The ASU supersedes FASB ASC 840,Leases, and creates a new FASB ASC Topic, 842,Leases. The new guidance applies to any entity that enters into a lease, as defined by the ASU.

Lessee Accounting.

As noted previously, lessees will be required to recognize a lease liability for the obligation to make lease payments and an associated right-of-use asset. The guidance retains a distinction between operating and finance leases. The classification criteria for distinguishing between those types of leases are substantially similar to the current criteria for distinguishing between operating and capital leases. For both finance and operating leases, a lease liability and a right-of-use asset are recognized and initially measured at the present value of the lease payments, in the balance sheet.

When measuring the lease liability and asset, the lessee includes payments to be made in optional periods only if it is reasonably certain to exercise an option to extend the lease (or to not exercise a termination option). Likewise, optional payments for the purchase of leased assets would only be included in the measurement of lease assets and liabilities by using the same threshold. Similar to current guidance, most variable lease payments are excluded from the lease asset and liability measurement.

Under the guidance in the ASU, lessees are required to account for finance and operating leases as follows:

• Finance Leases. Interest on the lease liability is required to be recognized separately from the amortization of the right-of-use asset in the statement of comprehensive income. Repayments of the principal portion of the lease liability are to be classified as financing activities in the statement of cash flows, while payments of interest on the liability and variable lease payments are to be classified as operating activities.

• Operating Leases. A single lease cost is to be recognized in the statement of comprehensive income based on the allocation of the cost of the lease over the lease term, generally on the straight-line basis. All cash payments are to be classified within operating activities on the statement of cash flows.

A lessee is also permitted to make an accounting policy election, by class of underlying asset, to not recognize lease assets and liabilities for leases with a term of 12 months or less. In such cases, lease expense is generally recognized on a straight-line basis over the lease term.

Lessor Accounting.

Lessor accounting under the new guidance remains essentially the same as current standards. Most operating leases will continue to be classified as operating leases by lessors, with lease income recognized on a straight-line basis over the lease term. However, specific changes are being made in the guidance, such as the modification of certain glossary terms to align with the changes made to the lessee guidance, as well as changes to aspects of the lessor accounting model to align with the revenue recognition guidance in FASB ASC 606,Revenue from Contracts with Customers.

Disclosures.

The new guidance requires disclosures for lessees and lessors in order to meet the overall objective of allowing financial statement users to assess the amount, timing, and uncertainty of cash flows from leases. Both qualitative and quantitative disclosures are required.

Other.

The ASU provides a definition of a lease. According to that definition, a lease is a contract (or part of a contract) that conveys the right to control the use of an asset for a period of time in exchange for consideration. Also, the ASU provides additional guidance on how to separate lease components from nonlease components in a contract.

Transition

Both lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The approach provides a variety of optional practical expedients that may be elected by an entity. In addition, the new ASU contains specific transition guidance for certain transaction types, such as sale and leaseback transactions and leveraged leases.

Effective Date

For (1) a public business entity, (2) a not-for-profit entity that has issued (or is a conduit bond obligor for) securities that are traded, listed, or quoted on an exchange or over-the-counter market, or (3) an employee benefit plan that files financial statements with the SEC, the ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.

For all other entities, the ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.

Early application of the ASU is permitted for all entities.

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      Accounting and Auditing Update (PPC)
        2016
          April 2016, Vol. 25, No. 4
            FASB Issues Lease Standard