Does your company or client lease assets such as real estate, airplanes or manufacturing equipment? If so, then you may want to keep reading...
In 2016, the Financial Accounting Standards Board (FASB) issued a new financial accounting and reporting standard that requires companies that lease assets (lessees) under operating lease arrangements to recognize those arrangements on their balance sheets.
You may be wondering “Why a change?” Given the prevalence of leasing in the marketplace, it’s important for users of financial statements to have a complete and understandable portrayal of a company’s commitments to leasing activities.
The standard is already effective for public companies and other organizations that file financial statements with the U.S. Securities and Exchange Commission. Private companies and nonprofits have an extra year to adopt the standard with the new effective date delayed to fiscal years beginning after Dec. 15, 2020.
Even though private companies and nonprofits have more time, doesn’t mean you should sit back and relax. Now isn’t the time to procrastinate. There’s an opportunity to learn from large public companies who have already implemented the standard.
CPAs need to gain a thorough understanding of the new requirements to ensure that they appropriately account for their company’s or client’s leasing arrangements. The new guidance includes extensive implementation guidance, illustrations and examples.
When implementing the standard, private company CPAs should consider the following:
Companies will be required to record a lease liability and a right-of-use asset for all operating leases
Finance leases (previously referred to as capital leases) will continue to be recognized by lessees on the balance sheet. The new guidance is not expected to have any significant impact on the income statement or cash flow statement.
A lease exists when there is an identified asset and a company using that asset has the right to control the asset.
A critical activity in implementing the standard is identifying all existing leasing arrangements. This includes analyzing all contracts, not just those that are papered as lease contracts. Leases exist in other contracts such as service contracts where the right to use an asset is “embedded” in the contract. Short-term leases (less than twelve months) do not have to be recognized on the balance sheet. However, disclosure of short-term lease costs is required for all periods presented in the financial statements.
Similar to the new revenue guidance, a lessee must determine whether separate components of a contract exist (lease and nonlease).
If so, the consideration in the contract must be allocated between the separate components. Lease components are accounted for within the leasing guidance while nonlease components are accounted for within other applicable GAAP. However, a shortcut for lessees exists where they can account for the entire arrangement in accordance with the leasing guidance in certain circumstances.
A key area for consideration when measuring lease assets and liabilities is the lease term, which includes the consideration of renewal options in certain circumstances.
Companies must also determine the appropriate rate to discount the lease payments. Generally, a lessee will use its incremental borrowing rate, which is a collateralized rate. Private companies and not-for-profit organizations may use the risk-free rate as a shortcut.
Other important guidance to consider relates to how to account for modifications and impairment of lease assets.
Companies must comply with new detailed disclosure requirements. Additionally, it’s imperative to understand the transition requirements to ensure that lease assets and liabilities get recognized upon a company’s adoption of the standard.
Lastly, the FASB has a variety of implementation resources on its website, which includes a technical inquiry service where companies can submit questions to the FASB staff. Those resources can be located at www.fasb.org/leases. The AICPA leases webpage also features resources such as a learning and implementation plan and an online course. If you have any questions about implementing the standard, feel free to contact us.