The Financial Accounting Standards Board (FASB) has issued a new Accounting Standards Update, ASC 842: Leases, that addresses lease recognition under the U.S. Generally Accepted Accounting Principles (U.S. GAAP). The Standard resulted from a multi-year convergence project between FASB and the International Accounting Standards Board (IASB). The goal is to increase transparency and comparability among entities by recognizing lease assets and lease liabilities on the balance sheet and disclosing critical information about leasing arrangements.
We are fast approaching 2022, so it is time to consider the new leasing standard for calendar-year entities, which becomes effective January 1, 2022.
Who is affected by this Standard?
The Lease Standard affects any entity that enters into a leasing arrangement. There are specific exclusions for:
- Leases of intangibles
- Leases to explore for or use minerals, oils, natural gas, and similar non-regenerative resources
- Leases of biological assets, including timber
- Leases of inventory
- Leases of assets under construction.
There are also exclusions for short-term leases; however, consideration must be given to options to extend the lease in subsequent years.
What are the key provisions?
There are several of fundamental changes from previous GAAP and ASC 842, which we will highlight in later articles. These changes include:
- Definition of a lease
- Recognition of lease asset (right-of-use asset) and a lease liability for substantially all leases whose terms are 12 months or more.
- Balance sheet presentation changes
- Treatment of certain property taxes and insurance payments
- Definition of initial direct costs
- Finance leases instead of Capital leases
- Accounting for related party leases
How will ASC 842 impact financial statements?
Today we will focus on the balance sheet changes since that impacts what is ultimately reported in the financial statements.
Once we begin the new year, what was previously known as Capital Leases will now be Finance Leases. In addition to the name change, the four bright-line criteria indicators have also changed to a more principles-based assessment.
In terms of reporting, the most significant change is related to operating leases, which will be presented as Right of Use leases and are currently kept off-balance sheet. The Standard requires entities to calculate the value of the assets being used by the entity and a corresponding liability. The calculation also requires accumulating the future minimum lease payments over the lease term, including extensions, and determining the present value of the asset and liability. This new Right of Use asset will be depreciated over the term of the lease, and the liability will be amortized to the income statement over time.
Under current guidance, this information would typically be disclosed in the notes to the financial statements. The new guidance gives the Right of Use assets and lease obligations a more prominent place on the balance sheet and provides the financial statement users a transparent picture of the entities’ financial position.
Sources: FASB ASU No. 2016-02
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