On February 25, 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016- 02 Leases (Topic 842), a new standard that will govern the accounting for lease contracts beginning with the 2019 calendar year-end for public companies and the 2020 calendar year-end for all other entities. To affect these changes, this ASU amends the existing FASB Accounting Standards Codification (ASC) and creates a new Topic 842, Leases.
Big changes, bigger impact expected
It has been speculated that the release of ASU 2016- 02 could result in as much as $2 trillion in assets and liabilities being added to the balance sheets of U.S companies. Certain industries where it is common practice to hold numerous equipment and real estate leases, such as retail stores, telecommunications, restaurant chains, airlines, and banks, are expected to be most impacted. All companies with leases will be impacted to some degree, however, the final impact of the new leasing standard will vary, depending on the size and scope of a company’s leasing activities.
Companies need to start now to assess the capabilities of their financial reporting systems and controls, as they relate to the adoption of this new standard. The new lease standard requires a modified retrospective implementation approach, which means when companies adopt they will need to apply the new lease guidance to each comparable period presented. For instance, a public company who adopts for the 2019 calendar year-end and reports three years of comparable information will need to evaluate how the standard will impact the presentation of the 2017 and 2018 calendar year-end financial statements.
Lease assets and liabilities will be recorded on the balance sheet
The key difference between existing standards and ASU 2016-02 is the requirement for lessees to recognize on their balance sheet all lease contracts with lease terms greater than 12 months, including operating leases. Specifically, lessees are required to recognize on the balance sheet at lease commencement, both:
- A right-of-use (ROU) asset, representing the lessee’s right to use the leased asset over the term of the lease; and,
- A lease liability, representing the lessee’s contractual obligation to make lease payments over the term of the lease.
The new lease standard requires lessees to classify leases as either operating or finance leases, which are similar to the current operating and capital lease classifications. However, the distinction between these two classifications under the new standard does not relate to balance sheet treatment, but relates to treatment and recognition in the statements of income and cash flows.
Lessor accounting is largely unchanged from current accounting principles generally accepted in the United States (U.S. GAAP), with the exception of some revisions made to ensure consistency with the revised lessee guidance of ASU 2016-02 and with FASB ASC 606, Revenue from Contract with Customers.