LUTZ BUSINESS INSIGHTS
an update on lease accounting standards
katie byrd, audit manager
New nationwide accounting standards for leases are being phased in. Such standards are regulated by the Financial Accounting Standards Board (FASB), which initially defined them within the Accounting Standards Certification (ASC) of 1977. Now, those lease accounting standards—referred to as “ASC 842”–have been revised (in February 2016).
Some complications, or perhaps confusion, attended the introduction of the new standards because widespread criticism of the 2016 draft of the standards led to a second draft—now official—in 2018. Now, the new standards are fixed. Their implementation, however, is in stages.
The effective date of the new standards, which is when public companies must adopt the new lease accounting standard for preparing their financial statements, is fiscal years that begin after December 15, 2018. Thus, for a calendar year company, it would be effective January 1, 2019. The standards define a “public company” as an organization that is one of the following:
- A public business organization.
- A not-for-profit organization that has issued, or is a conduit bond obligor for securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
- An employee benefit plan that files or furnishes financial statements to the SEC.
After some skirmishing over a requirement of restating “comparable” years, the FASB announced that companies had the option of not restating those prior years. Privately held companies were permitted to delay compliance until the end of the fiscal year 2020. Any organization, however, may elect to apply the standards earlier than required.
The new standards
In understanding the new standards, it is important to realize that they revise and replace certain features, definitions, and regulations of the original, extensive 1977 regulations. Therefore, to fully comprehend the changes, familiarity with the 1977 terminology, distinctions, and assumptions is essential. With that caveat, this is a brief summary of the 2016-2018 changes.
The lessee. Under the new standard, organizations that lease assets (the “lessee”) must recognize on their balance sheet the assets and liabilities they incurred in exchange for the rights and obligations under those leases. (This requirement applies only to leases with terms of more than a year.)
In conformity with current Generally Accepted Accounting Principles (GAAP), how the lessee will handle the recognition, measurement, and presentation of the expenses as well as the cash flows incurred by the lease will depend on whether the lease is classified as a “finance” or “operating” lease. (The distinction has a long history in the earlier regulations, where “finance” leases were referred to as “capital” leases.) Departing from current GAAP, however, which requires only “capital” leases to be recognized on the balance sheet, the new ASU requires both finance (capital) and operating leases to be so recognized. A goal of the new ASU is to help readers of financial statements to better understand the amount, timing, and uncertainty of cash flows arising from leases. Thus, there are requirements for new disclosures in the statements.
The lessor. For organizations in possession of the leased assets (the “lessor”), accounting under the new regulations is largely unchanged from current GAAP. Nevertheless, the new ASU does impose some changes that are intended to align lessor accounting with lessee accounting (and also with the updated revenue recognition guidance issued in 2014).
Goals of the new ASU standards for lease accounting
There are the half-dozen articulated goals of the new ASU standards:
- To improve the representation of a lessee’s rights and obligations incurred by leases.
- To narrow the opportunities for organizations to manipulate the structure of lease transactions to support certain presentations on their balance sheets
- To make it easier to understand and compare the financial statements of various lessees.
- To align the lessor’s accounting, sale, and leaseback transactions with guidance already in place for earlier (2014) regulation.
- To provide users of financial statements with more information about the lessor’s leasing activities and the risks to the credit and assets of the lessee.
- To clarify the definition of a “lease” within current GAAP practice.
What is the expected impact?
The U.S. Securities and Exchange Commission (SEC) estimates that operating lease commitments as of 2015 (the latest figure available) were $2 trillion. Recall that the FASB specified that operating lease liabilities must be categorized as “non-debt liabilities,” and therefore, should not affect balance sheet debt ratios or loan covenants.
Nevertheless, the addition of an equal asset and liability will reduce most companies’ quick ratio. At the same time, though, an operating lease is a current liability without offsetting current assets and so reduces the current ratio. Both ratios are prominent in the balance sheet summaries of companies such as retail chains (leasing stores) and airlines (leasing aircraft).
Rely on Lutz
For more information on new accounting standards on leasing or any aspect of taxes, accounting, assurance, or business consulting and valuation, get in touch with Lutz. Since 1980, we have supported clients with the strength, expertise, and resources of 200 independently owned global firms of the Leading Edge Alliance. We have become the largest locally owned firm of our kind in Nebraska by making your goals our goals.
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ABOUT THE AUTHOR
KATIE BYRD + AUDIT MANAGER
Katie Byrd is an Audit Manager at Lutz with over four years of related experience. She provides assurance services to businesses with a focus on the retail, service, distribution, nonprofit, and franchise industries. In addition, Katie assists with transaction advisory services and employee benefit plans.
AREAS OF FOCUS
- Employee Benefit Plans
- Transaction Advisory Services
- Retail Industry
- Services Industry
- Manufacturing & Distribution Industry
- Nonprofit Industry
- Franchise Industry
AFFILIATIONS AND CREDENTIALS
- American Institute of Certified Public Accountants, Member
- Nebraska Society of Certified Public Accountants, Member
- Certified Public Accountant
- BSBA in Accounting, University of Nebraska, Lincoln, NE
- University of Nebraska-Lincoln School of Accountancy Junior Advisory Board, Board Member
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