In early 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) on leases. ASC 842 brought huge changes to public and non-public companies. The purpose of these changes was to enhance the financial statement disclosure and visibility into the leasing obligations, because prior to ASC 842 most leases were not reflected on the balance sheet. The new lease standard requires companies to report right-of-use (ROU) assets and liabilities for almost all leases onto the balance sheet, which is estimated at trillions of dollars!
With ASC 842, most leases are now required to be recorded on the balance sheet, which has added some complexities for lessee and lessor financial statement reporting and disclosures. ASC 842 retained the two-model approach, which classifies leases as either operating or financing (formerly known as capital). For lessees, a lease liability will be created based on the PV of the future lease payments and recognize the ROU asset. The lessee should use the discount rate to determine the PV of the implicit rate or the lessee’s incremental borrowing rate. Note that lessees that are non-public companies can use a practical method that permits them to make an accounting election to use the risk-free rate as the discount rate in the determination of the present value for all leases. Operating lease expenses are to be recorded on a straight-line basis over the term of the lease. Financing lease expenses recognize the interest expense plus the amortization expense accordingly. Note that lessors must classify the new lease as either a direct financing lease, sales-type lease, or operating lease.
ASC 842 also mandates accounting changes to lease modifications. Note that the proper treatment for these lease modifications depends on its nature. The two major types of lease modifications include 1) lessee gains additional rights not included in the original lease and 2) modifications that partially or fully terminate the lease. These lease modifications eliminate the ROU asset and lease liability from the books and the gain or loss is reflected in the income statement for when the termination occurs.
What are some of the new financial statement disclosure requirements? The objective of the new disclosures is to assist financial statement users when assessing the dollar amount, timing, and uncertainty of cash flows coming from these leases. Major points relating to lessee disclosures include the nature of the leases, lease transactions with related parties, operating and finance lease expenses, variable lease expenses, leaseback gains and losses, maturity analysis, weighted average discount rate, and remaining lease terms. Major points for lessor disclosures include the nature of the leases, operating lease maturity analysis, residual asset risk management, lease-related income, lease transactions with related parties, and significant assumptions and judgments used.
Our team of experts is here to help with implementing the new lease standard. Our firm has invested in a lease accounting software, UGAAP, that can help you with lease schedule maintenance, monthly/quarterly/annual journal entries, reports, and financial statement disclosures.