FASB Finalizes Simplifications for New Lease Standards
In February 2016, FASB released its new standards for lease accounting, commonly known as ASC 842. I wrote about those lease accounting changes here. Basically, capital and operating leases will now be accounted for in a similar fashion, with an asset representing the right to use the leased asset, and a liability for the future lease payments, both now appearing on the balance sheet.
Then, in response to financial statement preparers, who cited “unanticipated costs and complexities” in transitioning to the new lease standards, FASB released some proposed simplifications, which I wrote about here. Just this last July, FASB finalized those simplifications with the release of ASU 2018-11.
Let’s look at what the final update says.
Financial Reporting for the Year of Adoption is Easier
Prior to the latest update, companies were required to use a modified retrospective method in their financials for the year adoption. Public companies are required to adopt the new standard beginning Jan. 1, 2019, while private companies get another year.
Under the modified retrospective method, companies are required to present their financials for the year of adoption as if the standard had been in place since the earliest year presented. For example, if a company adopts the new standards in 2019, and their comparative financials show two prior years, then their 2019 financials will report results as if the standard had been in place since 2017. This means that companies have to examine all leases in place during those prior years, including leases that expired before the date on which the company adopts the new standard.
This latest update from FASB simplifies reporting for the transition year. Now, companies need only apply the new standard at the date of adoption. The balance sheet for the year of adoption will have a cumulative-effect adjustment to the beginning balance of retained earnings. The two prior years will be reported as they were under the previous standard, ASC 840. This is in alignment with the options for transitioning to the new revenue recognition standards in ASC 606, which I wrote about here.
For the years prior to adoption, the financial statement disclosures will include those required under the old standards, ASC 840. The financials will also include the expanded disclosures required under ASC 842 for the year of adoption.
Lessors Get a Break
Under the new lease standards, lease agreements that have both lease and non-lease components need to be split into their component pieces. For example, a lease for a piece of equipment might include maintenance for the duration of the lease. The non-lease component is accounted for under the appropriate non-lease standards, which will likely be ASC 606.
As a practical expedient in the initial update to the standards, lessees – but not lessors – were allowed to skip this separation for certain qualifying leases. Lessees can make an election by class of asset and account for the leases in those classes as single operating leases.
The latest update extends this practical expedient to lessors for leases that meet these qualifications:
- The non-lease components are appropriately accounted for under ASC 606.
- The timing and pattern of transfer for the lease and non-lease components is the same.
- The lease component would be classified as an operating lease.
If the lease component is the major component of the combined lease, then this single lease will be accounted for under the lease standards as an operating lease. But, if the non-lease components are the major components, the lease will be accounted for under ASC 606.
Lessors who adopt this practical expedient will have to disclose the following:
- They have elected this practical expedient.
- The class or classes of assets that they are applying this practical expedient to.
- The nature of the lease and non-lease components, plus any other non-lease components of the agreement that weren’t eligible to be combined and that are accounted for separately.
- Whether the combined lease will be accounted for under ASC 842 or under ASC 606.
These simplifications should ease the daunting process of implementation of ASC 842. However, FASB’s changes to the lease accounting standards are complex, so companies and their advisors should start working on implementing these standards as soon as possible.