Implementation Guidance for the New Leases Accounting Standard
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On February 25, 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842). Under the new ASU, lessees will be required to recognize lease assets and liabilities for all leases, with certain exceptions, on their balance sheets.
Public business entities (which may include certain not for profit entities who have issued debt securities) are required to adopt the standard for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. That means an effective date of January 1, 2019, for public entities with a December 31 year end.
Nonpublic entities have an extra year to adopt, which would be an effective date of January 1, 2020.
In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients. These practical expedients relate to the identification and classification of leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase the underlying assets.
An entity that elects to apply the practical expedients will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP unless the lease is modified, except that lessees are required to recognize a right‑to use (ROU) asset and a lease liability for all operating leases at each reporting date based on the present value of the remaining minimum lease payments that were tracked and disclosed under previous GAAP.
There is also specific transition guidance for sale and leaseback transactions, build‑to‑suit leases, leveraged leases, and amounts previously in accordance with business combinations guidance for leases.
Accounting for leases was a joint project of the FASB and the IASB. There are some significant differences between the two Boards’ final standards. These differences are outlined in the ASU.
Follow the steps below to ensure that your company as well as its management team and staff do the following:
- Understand the changes to current GAAP based on FASB ASU 2016-02, Leases.
Understand the transition requirements and determine how your company will adopt the new standard.
- Find resources to help train your professional staff to ensure effective and efficient implementation of the leases standard.
- Educate users and other stakeholders about the changes they can expect in your company’s financial statements.
The following is a suggested action plan for public entities to implement the new leases standard (nonpublic entities have an additional year to adopt the new guidance). You should be implementing these steps now.
|Assign company staff or a task force to become experts and take the lead on understanding and implementing the new leases standard. Input may be needed from a wide range of functions, including finance, accounting, and legal personnel.
|The core principle is that lessees should recognize the assets and liabilities arising from leases on the balance sheet.
The new standard retains the distinction between finance leases and operating leases, based on criteria that are substantially similar to the criteria for distinguishing capital leases from operating leases under current GAAP.
|Update lease inventories.
|Obtain information on company’s leases, wherever records of those leases are kept in the company.
|Decide on transition method.
|Determine whether or not to elect the optional practical expedients for applying the modified retrospective approach.
|Review legal agreements and debt covenants.
|Changes to the balance sheet may affect contractual agreements or debt covenants. You should contact lenders to amend debt agreements, if necessary, before the standard is adopted.
|Consider IT needs.
|Consider whether improvements to the company’s IT platform might be necessary.
|Discuss with stakeholders.
|The standard is complex and recognizing assets and liabilities for operating leases can have a significant effect on the balance sheet. Have conversations with stakeholders such as the Board of Directors, investors, and lenders about the effects of the new standard.