Prepared by Clayton Crider – Staff Accountant
Changes to the way we account for leases have been in the works for close to 3 years. These long-awaited changes will be effective for many companies starting in January of 2019. To improve transparency in financial reporting, the Financial Accounting Standards Board (FASB) issued new guidance related to leases with the finalization of ASC 842. Businesses that prepare GAAP based financial statements and lease equipment, space, or machinery, will be affected by the new guidance. There are also scenarios where a dedicated supply contract could be considered a lease under ASC 842. The new guidance follows a “right to use” model. Lessees will be required to show a “right to use” asset and a related lease liability on the balance sheet for the first time ever, related to leased assets. Material impacts are expected for operating leases commonly found among businesses of all sizes. Such leases are typically in place for office space, equipment, copiers, retail space, etc. This is something that was not required for operating leases under the old standard.
The guidance does not make substantial changes related to today’s lessor accounting model, but there are considerations to classifying what type of lease exists under the new guidance, with subtle changes related to disclosures and accounting.
Under ASC 842, a contract contains a lease if a specific asset is identified in the contract, and the lessee is in control of that asset during a specified period. It’s important to note that a lessee can be in control of an asset of a supplier, even if the asset is in the physical custody of the supplier. Leases with a term less than twelve months that have no purchase option are allowed to be treated like an operating lease under the previous lease guidance (ASC 840). Classification, recognition, and measurement of leases will occur at commencement date of the lease, and not at the inception date.
Other important changes under ASC 842 include:
• Certain incremental costs to obtaining a lease should be considered in calculating the right of use asset;
• Contracts that contain both lease and non-lease components must be separated with the lease components accounted for under the new guidance;
• Extension options are now considered as part of the total term of the lease based on a lessee’s likelihood of exercising an option;
• New rules relating to sale-leaseback transactions;
• New events are outlined that would cause a reassessment of lease terms and pricing;
• New criteria for recognizing profit for a sales-type lease;
• New guidance on how to handle lease modifications, and
• Several practical expedients to simplify business entities in transitioning to this new standard.
In addition to new leases, all existing leases should be examined to determine the effect of the new leasing standard. The biggest challenge many businesses will face is identifying all arrangements that could include a lease and analyzing those arrangements to determine if they fall under the scope of the new guidance. We specialize in providing consulting and accounting services to businesses of all sizes. If you think you will be impacted by the new guidance and would like assistance in assessing your potential impact, please give us a call and we can determine how your business can remain compliant.