“Transparency” is the big buzzword at the Financial Accounting Standards Board (FASB), and new lease accounting rules that went into effect beginning in January 2019 are part of a FASB push to make it easier to see into and through the leasing accounting process.
Coming as it does in the wake of new revenue recognition rules, the requirements pose a major accounting recalibration challenge to public and private companies that employ generally accepted accounting principles (GAAP) reporting. Public companies were required as of Jan. 1, 2019 to adhere to the new rules; private companies have until Dec. 15, 2019 to comply.
It would be disingenuous to suggest that a blog item is more than a means of hitting some of the high points of Accounting Standards Update Topic 842 – and encouraging not a commitment, but a determination, to do what’s necessary to be well-versed and compliant with the new rules. The impact of Topic 842 is a mile deep, and a mile wide, in terms of their effect on lease reporting.
The 40-page Accounting Standards Update (ASU) Topic 842 is the GPS for entities to transition from reporting certain leases with lengths of more than 12 months as expenses to show them instead on balance sheets.
As ASU Topic 842 says:
“This means that starting on January 1, 2017…lessees must recognize lease assets and liabilities for all leases even though those leases may have expired before the effective date. Lessees also must provide the new and enhanced disclosures for each period presented, including the comparative periods.”
FASB has made allowances for the organizations on the receiving end of the new rules in how they must be implemented. The modified retrospective transition method is one option, which existed under the previous rule. An entity using this method applies the new standard (“subject to specific transition requirements and optional practical expedients”) at the start of the earliest period of an entity’s financial statements. That date would be Jan. 1, 2017, for public companies using a calendar year.
Lease assets and liabilities for all leases must be recognized by lessees even though, as noted above, the leases may have expired before the effective date.
As in many cases in which complex new language is employed and far-reaching changes are made, unintended consequences arose. FASB heard from the rules’ end-users who were “observing some anticipated costs and complexities associated with the modified retrospective transition method, particularly the comparative period reporting requirements previously described.”
As a result, organizations can apply the new standard as of the adoption date “and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption consistent with the preparers’ requests.”
“Embedded leases” are among topic areas that have attracted a good deal of attention in Topic 842. When a user has control of an asset in such a way as to meet the legal definition of a lease, it’s called an embedded lease, though the word “lease” may never appear in the contract. These can no longer act as de facto but unrecognized leases; they must be recognized and go to the balance sheet. This puts a premium on accurate and verifiable identification of lease vs. non-lease components within a contract.
Hopefully, it’s apparent that the new rules can’t be instituted without a good deal of work and attention to detail. To further illustrate that reality, here are just two sentences from the Topic 842 section on “Separating Components of a Contract”: “Specifically, if the nonlease component or components associated with the lease component are the predominant component of the combined component, an entity should account for the combined component in accordance with Topic 606. Otherwise, the entity should account for the combined component as an operating lease in accordance with Topic 842.”
And that’s just one component in the 40 pages of rules and background.
Get yourself expert help – truly expert help – and ensure your lease reporting meets the new requirements. For transparency’s sake. And your company’s. Otherwise, you’re going to be a mile deep in a compliance hole with all of the attendant costs, time, and pressure needed to climb out.
You can read Topic 842 in its entirety here.
