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by Francisca Franco, CPA, CFF, CVA : SingerLewak

The Financial Accounting Standards Board (FASB) issued a major change to the lease accounting rules, ASC Topic 842 (“Topic 842”), to increase transparency and comparability among entities by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing transactions.  A focus of the FASB was to address concerns with the lessee’s accounting for operating leases.  Specifically, Topic 842 requires lessees to recognize the assets and liabilities arising from leases on the balance sheet.  

Topic 842 became effective for public business entities and certain non-for-profit entities for financial statements issued for fiscal years beginning after December 15, 2018 and interim periods within the fiscal years beginning after December 15, 2018.   All other entities are required to apply the new rules for financial statements issued for fiscal years beginning after December 15, 2019 and interim periods within the fiscal years beginning after December 15, 2020. 

The following is a summary of some of the key requirements under the new rules that impact the recognition of lease assets and liabilities, the transition periods, practical expedient options, and lease classifications. 

LEASE ASSETS AND LIABILITIES

The implementation of Topic 842 requires lessees to recognize the assets and liabilities arising from leases on the balance sheet in order to clearly reflect the economics of leases.    “A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.” [1]  It is important to note that Topic 842 permits the lessee to make an accounting policy election for short-term leases (defined as having a lease term less than a year) by class of asset where the entity would not recognize a lease asset and lease liability. 

TRANSITION METHODS

Due to the complexity in implementing the new lease standard, the FASB has provided entities the option of electing from the following two transition methods:

  • The first transition option is to apply the effect of Topic 842 retrospectively to each prior reporting period presented in the financial statements with the cumulative effect at the beginning of the earliest comparative period presented.

Under this transition method, the entity will adjust equity and the other comparative amounts disclosed for each prior period presented in the financial statements.  Essentially, the presentation is as if Topic 842 had always been applied.

  • The second option is to apply the standard retrospectively at the beginning of the period of adoption through a cumulative-effect adjustment. Under this transition method, the application date is the beginning of the reporting period in which the entity first applies Topic 842. [2] 

PRACTICAL EXPEDIENTS

In addition to the two transition methods summarized above, the entity has the option to make the following elections for practical purposes (“practical expedients”):

A. The entity may elect the following practical expedients, which must be elected as a package and applied consistently by the entity to all of its leases whether the entity is a lessee or a lessor:

  1. An entity need not reassess whether any expired or existing contracts are or contain leases.
  2. An entity need not reassess the lease classification for any expired or existing leases.
  3. An entity need not reassess initial direct costs for any existing leases.

B. The entity may elect to use hindsight to determine the lease term when considering to extend or terminate the lease and to purchase the lease asset. This expedient may be elected separately or in conjunction with the practical expedient per “A” above.

LEASE CLASSIFICATION

An entity is required to classify each separate lease component at the commencement date, which is when the lessee takes control of the underlying asset.  The following diagram highlights the key classification requirements:   

Note: Under Topic 842, the lease classification assessment process is more subjective than under the prior standards.  

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In summary, Topic 842 was issued to increase transparency and comparability among entities by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing transactions.  One of the major changes per this standard is to require all lessees to recognize the assets and liabilities arising from leases, including operating leases.   The prior standard (Topic 840) did not require lease assets and liabilities to be recognized for operating leases.  This summary of Topic 842 is not intended to be a comprehensive depiction of the changes per Topic 842.  For a comprehensive understanding of the impact of Topic 842 on your financial statements, please see the link below to the complete guidance update. 

FASB TOPIC 842

[1] FASB Leases Topic 842 –  Accounting Standards Update Targeted Improvements

[2] FASB Leases Topic 842 –  Accounting Standards Update Targeted Improvements

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