Client Accounting Services

New Lease Accounting Guidance Issued by FASB

Posted on March 14, 2016 by

Dave Van Damme

Dave Van Damme

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On February 25, 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-02 Leases (Topic 842), which provides new guidance on lease accounting. The new leasing standard will have a significant impact on the balance sheets of lessees. The lessor accounting has also been updated and will align with some of the changes to the lessee accounting and certain aspects of the new revenue recognition standard.

The revisions to accounting for leases will impact nearly all business entities. The standard was originally part of the convergence efforts between the FASB and the International Accounting Standards Board (IASB). However, the final decision was made to issue two separate standards as the two boards could not find common ground on the leasing standard. The discussion herein focuses on the standard as issued by the FASB.

Lessee accounting basics

The new leasing model requires a lease to be classified as either operating or finance using similar criteria to the existing lease accounting. However, both an operating lease and a finance lease will require recognition of a right-of-use asset and a lease liability on the balance sheet (there is an exception for leases that meet the definition of a short-term lease which is 12 months or less including any renewal periods).

The right-of-use asset is initially measured at the present value of the lease payments. Once the right-of-use asset and lease liability are recorded, operating leases will result in a straight line expense to amortize the right-of-use-asset over the lease term. The lease liability will decrease as payments are made.

Finance leases will have amortization expense related to the right-of-use asset, and interest expense recorded on the lease liability. The lease liability is treated like debt, similar to the capital lease accounting we have today. This will result in higher amounts of lease expense recognized early in the lease and lower lease expense in the later years, due to the declining liability balance and related interest expense.

Lessor accounting basics

The new leasing model does not result in significant changes to the lessor accounting. Lessors will still classify leases as operating, direct financing, or sales-type leases. There is a new requirement for the lessor to assess the collectability of the lease payments. The lessor changes align the accounting with the lessee accounting, and the lease revenue is subject to the new revenue recognition standard.

Sale-leaseback transactions

The revised leasing standard also impacts sale-leaseback transactions by linking the decision as to the existence of a sale to the new revenue recognition guidance. In the new model, a sale-leaseback transaction will qualify as a sale when:

  • It meets the criteria for a sale in the new revenue recognition standard.
  • The leaseback is not a sales-type or finance lease.
  • If there is a repurchase option, it is priced at the asset’s anticipated fair value on exercise and is not a specialized asset.

If the transaction can be treated as a sale, then the leaseback is analyzed the same as all other lease transactions. However, if the transaction cannot be treated as a sale, it is recorded as a financing transaction.

Effective date

The new lease guidance will be effective for public business entities for periods beginning after December 15, 2018, and for private companies in periods beginning after December 15, 2019. The standard requires modified retrospective application.

Transition considerations

There are a number of things that should be considered in advance of the implementation date to minimize the impact to your business. Because of the additional assets and liabilities that will have to be recorded on the balance sheet when the new standard is implemented, there may be significant impacts on many of the financial metrics provided to management, owners, and third parties (i.e., debt covenants). Business owners should evaluate if leasing provides as much of a benefit as in the past since a lease no longer provides off-balance sheet financing.

Some of the steps to take in preparing for the new leasing standard are as follows:

  • Accounting personnel should get an understanding of the standard and should help educate anyone in the organization who may be responsible for negotiating new leases.
  • Perform a review of existing leases and record them in a central place.
  • Quantify the anticipated effects of the new standard on existing leases as of the implementation date.
  • Put the systems and controls in place to capture all of the data that will be required to properly account for the leases.
  • Communicate the impact of the implementation of the standard with the bank or other key stakeholders.
  • Determine if a special purpose framework such as the AICPA Framework for Financial Reporting for Small and Midsize Entities (FRF-SMEs) would be more beneficial to the readers of the financial statements. The new leasing standard and revenue recognition standard will not impact the FRF-SMEs.

Dave Van Damme

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Dave leads the advisory & assurance practice and is well known inside and outside the firm for being both engaged & positive.

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