The new lease accounting standard is estimated to bring $2 trillion of lease liability into S&P 500 balance sheets. Learn how to prepare and implement the new leasing standard with our concise, easy-to-understand guide.
As a result of the COVID-19 pandemic, there may be various accounting and financial reporting considerations specific to the application of the US GAAP and IFRS lease accounting requirements, including those introduced by the FASB’s new lease accounting standard (ASC 842). Certain of these considerations include:
Accounting for rent concessions, rent forgiveness, and/or rent deferral Right of use asset impairment Applying the lease modification requirements Determining key assumptions in measuring the lease in this environment (e.g. discount rate) Evaluating certain transactions that may result from business interruption (e.g., sale and leaseback transactions)In response to COVID-19, the Financial Accounting Standards Board has proposed the deferral of the new lease accounting standard effective date for certain entities:
For private companies, including private not-for-profit entities, to fiscal years beginning after December 15, 2021, and interim periods beginning after December 15, 2022. For public NFPs, to fiscal years beginning after December 15, 2019, including interim periods therein, only if they have not already issued financial statements.
After almost a decade of planning, the Financial Accounting Standards Board (FASB) issued a new standard on accounting for leases (ASU 2016-02) in February 2016. Set to start going into effect at the end of 2018, this new guideline impacts entities across all industries that enter lease arrangements and sign contracts containing leases to support their business operations.
Deloitte’s new lease accounting guide details the most significant changes that ASC 842 requires for both lessees and lessors.
The new leasing standard represents a change in guidance for the definition of a lease, and entities are now required to identify whether a contract contains a lease when it is initiated. A contract is defined as a lease if it gives a customer the right to control the use of the identified property, plant, or equipment for any period in exchange for consideration.
Control is considered to exist if the customer has:
The “right to obtain substantially all of the economic benefits from use of an asset.”The “right to direct the use of that asset.” This definition differs from existing the US Generally Accepted Accounting Principles (GAAP), which requires the lessee to meet only the first requirement. Under the new standard, it’s up to the entity to determine whether it obtains the “right to direct the use” of the asset.
The new standard also requires organizations to identify the lease and nonlease components of any contract containing a lease. While this requirement is the same as under existing US GAAP, the impact of not applying this requirement is more significant because most leases must be recognized on the balance sheet under the new guidance.
Deloitte’s lease accounting guide (updated for subscribers as of June 2020) highlights some of the more challenging aspects of ASC 842. Navigate the tiles below for several examples.
Lessees are likely to be most significantly affected by the new FASB lease accounting standard. While ASC 842 retains the two-model approach to classifying leases as operating or finance, most leases must now be recorded on the balance sheet. Shorter leases may be exempt: Lessees may adopt an accounting policy not to record leases with terms of 12 months or less.
When a lease is recorded, a liability must be recognized based on the present value of future lease payments, with an offsetting entry to recognize a right-of-use (ROU) payment. Present value will be determined based on the rate implicit in the lease, or the lessee’s incremental borrowing rate.
While both operating and finance leases will be recorded on the balance sheet, the expense recognition pattern differs. Operating leases require lease expense to be recognized on a straight-line basis over the lease term, while finance leases require the lessee to recognize interest expense and amortization expense. As a result, the lessee will usually recognize a greater expense earlier in the life of the lease for a finance lease.
Lessors will also see a potential effect on their financial statements and disclosures. Most importantly, the profit recognition requirements under the lessor model match those under the FASB’s new revenue recognition requirements, and the lease classification criteria are now consistent with those for a lessee. The ASU requires a lessor to classify a lease as a sales-type lease, direct financing lease, or operating lease based on the new standard’s classification criteria.
With the new lease standard scheduled to go into effect for public entities by the end of 2018, organizations must start planning now to implement new—or change existing—business processes and internal controls to comply with the new guidance.
For public entities, ASC 842 will go into effect for the annual period beginning after December 15, 2018, and calendar year 2019. For other entities, ASC 842 goes into effect for fiscal years beginning after December 15, 2021 (i.e., will be effective for calendar year-end companies on January 1, 2022.)
Businesses will adopt ASC 842 by using a modified retrospective transition approach—implementing the standard as of the earliest period presented and through comparative periods in the financial statements. This modified approach helps maximize comparability while reducing the complexity of the transition.