(ASC Topic 842)

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. To affect these changes, this ASU, along with several related ASUs issued subsequently, amends the existing FASB Accounting Standards Codification (ASC) and creates a new Topic 842, Leases.

In the United States, the standard is effective for private companies for fiscal years beginning after December 15, 2019 and interim periods within fiscal years beginning after December 15, 2020. For public business entities, certain not-for-profit entities, and employee benefit plans that file financial statements with the U.S. Securities and Exchange Commission, the standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.

The new lease standard replaces existing lease guidance included in ASC Topic 840, Leases. The key difference between existing guidance under ASC Topic 840 and the new guidance under ASC Topic 842 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 their 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 lease term.

The new lease standard requires lessees to classify leases as either operating or finance leases, which are similar to the operating and capital lease classifications under ASC Topic 840. 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 U.S. GAAP, with the exception of some revisions made to ensure consistency with revised lessee guidance and with FASB ASC Topic 606, Revenue from Contracts with Customers.

Under legacy ASC Topic 840 guidance, accounting requirements for operating leases and service contracts were similar, and therefore some organizations may not have had robust systems and controls in place to identify embedded leases. With leases now being recognized on the balance sheet, the identification of embedded leases is more consequential.

With nearly all lease contracts being recognized on the balance sheet, implementation of the new lease standard could be operationally challenging to implement and will require an evaluation of an entity’s contracting activities and contract documents for embedded leases. This evaluation may involve judgment.

Companies are encouraged to develop an implementation plan and begin work toward implementation of the new lease standard as soon as possible.

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