On February 25, 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842). The new lease standard will take effect for fiscal years beginning after December 15, 2021. Early application is permitted. Below is a brief outline of the standard.
ASC 842 and ASC 840
The new lease accounting standards are significantly changing the accounting for operating leases. Under ASC 842, both operating and financing leases must be recorded on an entity’s balance sheet (previously, only capital, financing, leases were recorded).
Under the old standard, ASC 840, operating leases were considered an off-balance sheet transaction, and the associated expense was recognized in the income statement; there was no balance sheet impact. The absence of operating leases on the balance sheet made it difficult to understand the volume of a company’s commitments. Further, it made comparisons between companies difficult, depending on if they had different approaches to leased vs. capital assets.
In an effort to increase transparency, the FASB issued ASC 842, Leases. One of the provisions of this new standard is that all leases must be recognized on a company’s balance sheet. In addition, for operating leases, ASC 842 requires recognition of a right of use (ROU) asset and a corresponding lease liability upon lease commencement.
Note: An entity can make an accounting policy election to treat operating leases with a 12-month lease term consistent with the ASC840 recognition approach (no capitalization of the lease asset and no liability on the balance sheet). However, that election can only be made at the transition or commencement of the lease, and the lease does not have a purchase option that is reasonably certain of exercise.
Further, while ASC 842 does not have an exclusion for low-value assets, some companies choose to establish a capitalization threshold. Similar to a capitalization threshold for fixed assets, the company has determined that leases below this value are not material to the company and are not recognized.
Disclosure Requirements: Quantitative and Qualitative
The new standard requires expanded quantitative and qualitative disclosures by both lessees and lessors. Quantitative disclosures include:
- lease costs,
- other cash flow,
- supplemental non-cash information related to:
- lease liabilities,
- weighted average lease terms and discount rates, and
- maturity analysis of undiscounted cash flows.
Summing It All Up
The final standard can be summarized as moving operating lease obligations from the footnotes to the balance sheet. Bringing operating leases onto the entity’s balance sheet could make a significant difference in the numbers a company is reporting.
Now is the time to review all your lease agreements in effect at the transition date (January 1, 2022, for calendar year companies).
Please contact us with any questions or to schedule a time to discuss implementation. We can also provide you with the AICPA’s lease classification tool.