Heads Up — FASB's new standard brings most leases onto the balance sheet
As a result of discussions with the FASB staff after the issuance of this publication, we have revised our interpretive guidance on the income recognition pattern related to lessor accounting for operating leases.
After working for almost a decade, the FASB has finally issued its new standard on accounting for leases, ASU 2016-02. The IASB issued its own version, IFRS 16, in January, and although the project was a convergence effort and the boards conducted joint deliberations, there are several notable differences between the two standards.
The primary objective of the leases project was to address the off-balance-sheet financing concerns related to lessees’ operating leases. However, developing an approach that requires all operating leases to be recorded on the balance sheet proved to be no small task. During the process, the boards had to grapple with questions such as (1) whether an arrangement is a service or a lease, (2) what amounts should be initially recorded on the lessee’s balance sheet for the arrangement, (3) how to reflect the effects of leases in the statement of comprehensive income of a lessee (a point on which the FASB and IASB were unable to converge), and (4) how to apply the resulting accounting in a cost-effective manner.
Accordingly, the FASB’s new standard introduces a lessee model that brings most leases on the balance sheet. The standard also aligns certain of the underlying principles of the new lessor model with those in ASC 606, the FASB’s new revenue recognition standard (e.g., evaluating how collectibility should be considered and determining when profit can be recognized). Furthermore, the ASU addresses other concerns related to the current almost-40-year-old leases model. For example, it eliminates the required use of bright-line tests in current U.S. GAAP for determining lease classification. It also requires lessors to provide additional transparency into the exposure to the changes in value of their residual assets and how they manage that exposure.
The new standard, which is effective for calendar periods beginning on January 1, 2019, for public business entities and January 1, 2020, for all other entities (see the Effective Date section for more information), represents a wholesale change to lease accounting, and as a result, entities will face significant implementation challenges during the transition period and beyond, such as those related to:
- Applying judgment and making estimates.
- Managing the complexities of data collection, storage, and maintenance.
- Enhancing information technology systems to ensure their ability to perform the calculations necessary for compliance with reporting requirements.
- Refining internal controls and other business processes related to leases.
- Determining whether debt covenants are likely to be affected and, if so, working with lenders to avoid violations.
- Addressing any income tax implications.
See Appendix F of the Heads Up for more information about an entity’s implementation considerations.
This Heads Up provides a comprehensive overview of the FASB’s new leases accounting model under ASU 2016-02 and highlights a number of implementation considerations. The Heads Up also contains the following appendixes, which expand on certain key aspects of the standard:
- Appendix A — Evaluating Whether an Arrangement Is or Contains a Lease.
- Appendix B — Other Significant Provisions. (Topics discussed include lease modifications, separating lease and non-lease components, and accounting for sale-and-leaseback transactions.)
- Appendix C — Presentation Requirements.
- Appendix D — Disclosure Requirements.
- Appendix E — Transition.
- Appendix F — Implementation Considerations.
View the rest of the Heads Up.
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Heads Up newsletters, published as warranted, analyze important accounting developments, such as new FASB and IASB pronouncements or exposure drafts. Concise examples and answers to frequently asked questions assist readers in understanding and implementing the critical guidance.