Share this content
lease calculator
iStock_KUO CHUN HUNG_lease calculator

The Wait is Over: FASB Issues New Guidance on Lease Accounting

Feb 25th 2016
Share this content

The Financial Accounting Standards Board (FASB) officially released its long-awaited lease accounting standard on Feb. 25, which now requires companies to report most leases on their balance sheets and puts an end to the off-balance-sheet reporting of assets and liabilities related to the rights and obligations created by operating leases.

While companies are currently required to disclose lease commitments in the footnotes of their financial statements, they will now have to add lease obligations to their books instead.

“The new guidance responds to requests from investors and other financial statement users for a more faithful representation of an organization’s leasing activities,” FASB Chairman Russell Golden said in a written statement. “It ends what the US Securities and Exchange Commission and other stakeholders have identified as one of the largest forms of off-balance-sheet accounting, while requiring more disclosures related to leasing transactions.

“The guidance also reflects the input we received during our extensive outreach with preparers, auditors, and other practitioners, whose feedback was instrumental in helping us develop a cost-effective, operational standard,” he added.

The new standard affects all companies and organizations that lease assets, like real estate, airplanes, and manufacturing equipment. According to a recent study by equipment leasing software provider LeaseAccelerator, public companies that will likely be impacted the most by the lease accounting overhaul include Walgreen Co., AT&T Inc., McDonald’s Corp., and Delta Air Lines Inc.

“This is not a regulatory issue that can be easily solved by the compliance officer. It is a big data problem and a business-process problem that will require the attention, coordination, and time of the entire C-suite,” LeaseAccelerator CEO Michael Keeler said in a written statement. “The accounting is not that complicated, and there is software already built and ready to use. It’s the data and the data management that possess the biggest problem. With thousands of leases spread around 50 countries for many of these large organizations, it will take a monumental effort to aggregate and gain insight on their current lease exposures.”

New Financial Reporting Requirements for Lessees
Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), will now require organizations that lease assets – or lessees – to recognize assets and liabilities on their balance sheets for leases with lease terms of more than 12 months.

Previously, the recognition, measurement, and presentation of expenses and cash flows arising from a lease for lessees primarily depended on its classification as a finance (capital) lease or operating lease. But unlike current US GAAP, which requires only capital leases to be recognized on the balance sheet, the new standard requires companies to include both types of leases on their books.

“This is a huge change from current practice,” said Anne-Lise Vivier, CPA, accounting publications managing editor with Thomson Reuters Checkpoint within the Tax & Accounting business of Thomson Reuters. “Lessees will, in most cases, have to record a large asset and a large liability on their balance sheet. Companies will no longer be able to structure lease agreements to achieve off-balance-sheet reporting and will, in many cases, have to monitor the effect of this change on their debt-to-capital ratio and related debt covenants, among other things.”

For finance leases, lessees will be required to:

  • Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payment, in the statement of financial position.
  • Recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of comprehensive income.
  • Classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows.

For operating leases, lessees will be required to:

  • Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payment, in the statement of financial position.
  • Recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis.
  • Classify all cash payments within operating activities in the statement of cash flows.

The ASU also will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements.

Ralph Petta, president and CEO of the Equipment Leasing and Finance Association, believes the new guidance will not prevent companies from acquiring the necessary equipment to grow their businesses.

“There are many reasons to lease equipment, and the primary reasons will remain intact under the new rules – from maintaining cash flow, to preserving capital, to obtaining flexible financial solutions, to avoiding obsolescence,” he said in a written statement.

Lessor accounting will remain largely unchanged. “For example, the vast majority of operating leases should remain classified as operating leases, and lessors should continue to recognize lease income for those leases on a generally straight-line basis over the lease term,” according to the FASB.

Don’t Delay on Implementation
Public companies will be required to adopt the new standard for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2018. For calendar year-end public companies, this means an adoption date of Jan. 1, 2019, and retroactive application to previously issued annual and interim financial statements for 2018 and 2017.

Nonpublic companies will be required to apply the new leasing standard for fiscal years beginning after Dec. 15, 2019, and interim periods within fiscal years beginning after Dec. 15, 2020. For nonpublic calendar year-end companies, this means an adoption date of Jan. 1, 2020, and retroactive application to previously issued annual financial statements for 2019 and 2018.

Early application will be permitted for all organizations.

The effective date might seem like a ways away, but companies should begin preparing for the new lease accounting requirements now, Vivier said.

“With many companies having very large portfolios of leases, this long adoption period is only the sign that companies will have a lot of work to get ready by the effective date,” she added.

The International Accounting Standards Board (IASB) published the international version of the standard, IFRS 16 Leases, on Jan. 13, which is effective for annual reporting periods beginning on or after Jan. 1, 2019. While there are similarities between the US and international rules, the IASB opted for a single-model approach that requires lessees to classify all leases as finance leases.

“When the new FASB and IASB leases standards take effect, they’ll provide investors across the globe with more transparent, comparable information about lease obligations held by companies and other organizations,” Golden said.

Sandy Peters, CPA, CFA, head of the Financial Reporting Policy Group at CFA Institute, said even though the global association for investment professionals had advocated for a different measurement method for the liability and an income statement recognition approach consistent with the IASB, the recognition of the liability in the new FASB guidance “is a major step in the right direction for investors.”

Related articles:

10 US Companies Most Impacted by New Leases Standard
All Systems Go for FASB Lease Accounting Overhaul