What You Need to Know About Lease Accounting
In February 2016, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) No. 2016-02, Leases, which created a new FASB Accounting Standards Codification (ASC) topic, FASB ASC 842, Leases. The goal of ASC 842 is to ensure greater transparency in financial reporting and better address the needs of users of financial statements.
Since its release, Lease Accounting has been one of the hottest topics in accounting, and as its effective date comes closer, now is the time for organizations to pay attention.
This will be a significant change for both private and public companies. For public companies, the ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For other organizations not considered public companies, the ASU is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted.
What is the Impact?
Under the new standard, certain obligations which have historically been disclosed as off-balance sheet obligations must now be recorded as part of a company’s balance sheet. Management teams may be asking themselves:
- What are the basic principles I need to understand?
- When does this become relevant for my company?
- How much work will this create for my team?
- What additional information will need to be disclosed in our financial statements?
More specifically, the question we most often hear is, “Why would we consider a lease a capital asset if we do not own or have the right to own the related asset?” Under the ASC, the definition itself of a lease is modified to be: “A contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.”
The most common example of this is the traditional “operating lease”. For example, a company leases office space for a period of time from a landlord. Historically, this was kept off the balance sheet as it was not an owned asset. However, under the new guidance, this must be recorded under the idea of the “right to control the use of” concept. Under the new guidance, the term “operating lease” will remain relevant, but under a new set of parameters. Within ASC 842, a distinction is made between “finance” and “operating” leases, which impacts the method by which the related amortization and interest expenses are recorded.
Why You Should Act Now
It is important for companies to begin thinking about the new leasing accounting standard and its implementation sooner rather than later as there are certain complexities to the related accounting as well as considerations to be made, including:
- Has the criteria within ASC 842-10-15 been evaluated to determine if a lease exists or not?
- Has the determination been made as to the classification of the asset between operating and finance-type leases?
- How will you calculate the asset and liability to record:
- Inclusion of initial direct costs;
- Present value of lease payments;
- Consideration of residual guarantees;
- Term for the estimated life of the asset;
- the related interest and amortization components.
The team at The MFA Companies is here to help. If you have questions about how the new lease accounting standard affects your business or how to implement it, contact us today.
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