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New Lease Accounting – ASC 842

The Financial Accounting Standards Board (FASB) has issued a new Accounting Standards Update, ASC 842: Leases, that addresses accounting for leasing transactions under U.S. Generally Accepted Accounting Principles (U.S. GAAP). ASC 842 was issued to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities for substantially all leases. The new rules are a culmination of an almost decade-long convergence project between the International Accounting Standards Board (IASB) and FASB. While FASB’s and IASB’s intention was to align lease accounting globally, significant differences still exist between the two basis of accounting.

Who does ASC 842 impact?

The new lease standard affects all entities that enter into leases. Public companies, private enterprises and not-for-profit organizations are all impacted by this standard.

What are the key provisions?

  • A lease asset (right-of-use asset) and lease liability will be recognized for substantially all leases whose terms are 12 months or more. Currently, operating leases are kept off-balance sheet.
  • Income statement expense recognition will be similar to current U.S. GAAP.
  • Lease classification (operating vs. finance) under the new standard is similar to current U.S. GAAP. However, assets of a specialized nature with no alternative use to the lessor, will trigger finance lease classification.
  • Substantially all leases will create an asset and liability on the balance sheet, therefore, FASB feels that attention will shift toward the determination of whether or not an arrangement contains a lease. As a result, the new standard has extensive guidance on the identification of a lease. Services arrangements would typically not result in the recognition of an asset and liability.
  • Lessor accounting is substantially unchanged.
  • Related party lease accounting shifts away from substance based or intent based criteria under current U.S. GAAP to accounting for legally enforceable terms under the new standard.

When do organizations have to implement ASC 842?

Public entities: Public entities are required adopt the new lease standard for fiscal years beginning after December 15, 2018.

All other entities: Private entities are required to apply the new guidance for fiscal years beginning after December 15, 2019 (i.e. December 31, 2020 year-ends).

How will ASC 842 impact financial statements?

A right-of-use asset (long-term asset) and a lease liability, with a current and long-term portion, will be recognized for substantially all leases. What does this mean? Certain debt covenants and financial ratios that companies look at regularly, such as working capital, debt to equity among others, could be impacted.

Can we issue statements with a GAAP departure?

Yes, but we caution organizations to consider the users of their financial statements before making this decision. For example, if financial statements prepared in accordance with U.S. GAAP are required by a lending agency, the organization should discuss the U.S. GAAP departure with the lending agency first, so they do not fall out of compliance with their debt covenants.

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