For multiple years now (decades, really), there has been an ongoing debate regarding the convergence of international (IFRS) and US (GAAP) accounting standards. However, up until recently there haven’t been any significant changes actually implemented that pushed this convergence into reality. As if to give us in the accounting world some indication as to whether a combined set of global accounting standards is actually possible (as I am sure there are many of you waiting on the edge of your seat), on February 25, 2016 the FASB ushered in ASC 842: Leases.
While it would be easy to drown you with minutiae on this topic, I’m going to try to keep it to the key points. But just for perspective, this blog is about 2 pages while the FASB accounting standards update on the topic is 191 pages. For this reason, I highly recommend looking into the “resources” section at the bottom of this blog or contacting us directly for additional guidance. See our contact page at Contact.
This revised accounting standard will likely have some effect on all businesses engaged in leasing activities, but the bulk of the changes will come for lessees in particular. So, in an attempt to keep it brief, I’m just going to discuss the lessees.
Previously, under US GAAP lessees could treat a lease as operating (income statement approach) or financing (balance sheet approach) based on defined criteria. Here are the journal entries to illustrate the difference:
Operating Lease (Income Statement Approach)
DR Rental Expense $XXXX
CR Cash $XXXX
Finance Lease (Balance Sheet Approach)
DR Asset $XXXX
CR Lease Obligation $XXXX
Scheduled Cash Payment
DR Interest Expense$XXXX
CR Lease Obligation$XXXX
The IASB did not particularly like this. They felt that an income statement approach to recording leases did not offer a user of the financial statements a complete picture of a company’s existing liabilities. While the FASB fought to maintain the dual approach, it seems as though they have finally folded (with some exceptions – to no one’s surprise).
In its most simplistic form, the outcome is this: going forward, a lessee should record an asset and a related liability for generally all leases (adopt a balance sheet approach). The lessee will then use the effective interest method to subsequently account for the lease liability. Note – there are some specific exceptions to the types of leases that will be accounted for using this guidance, so I’d like to reiterate that review of the resources provided below is highly recommended.
Here’s where things can get a little confusing. The FASB is maintaining that there is still a distinction between a financing lease and an operating lease. Under a financing lease, the asset is amortized on a straight-line basis and the amortization expense is recognized as a single line item on the income statement. The interest expense on the lease liability is recognized as a separate line item on the income statement. Under an operating lease, the expense recorded on the income statement is generally measured on a straight line basis and presented as a single expense line item. And to add to the fun, the FASB has slightly revised their criteria for determining the nature of the lease (operating vs financing), which includes added considerations for classification. There is also a bit more judgment involved in determination. In order to keep it to the key points, as promised above, I won’t go into all of the details here. The resources below can provide a full profile of these changes.
If you’re feeling a little overwhelmed and/or confused – there is some good news! You’ve got plenty of time to review the related guidance and determine the proper treatment for existing and future leases. The timeline for required implementation is as follows:
Public entities – Adoption is required for fiscal years, and interim periods within those fiscal years, beginning on January 1, 2019.
Nonpublic entities – Adoption is required for fiscal years, and interim periods within those fiscal years, beginning on January 1, 2020.
Early adoption for all entities is permitted and may be implemented as early as fiscal year 2016, and interim periods within those fiscal years. Note also that an entity may apply this guidance prospectively and does not need to reassess any existing or expired leases in order to comply.
Up until the point of adoption, the team at High Rock is more than happy to assist your company to ensure you are compliant!
“In Depth: The leasing standard – A comprehensive look at the new model and its impact”
“Heads Up – FASB’s new standard brings most leases onto the balance sheet”
“Dbriefs webcast – Discussing the FASB’s new leases standard”
“ASC 842 – Leases”
“FASB Accounting Standards Update No. 2016-02: Leases (Topic 842)”