Those who lease assets such as commercial real estate, office space, production facilitate and other assets such as farming or manufacturing equipment will soon be required to change the way they report leasing activities. On February 25, 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU), designed to enhance the transparency of a company’s leasing obligations. The changes specifically apply to the reporting of operating leases on a company’s financial statements. To help clients, prospects and others understand the changes; Hanson & Co has provided a summary of key information below.
Under the current accounting model, an organization determines accounting for the lease arrangement based on a simple classification test:
If the lease can be classified as a capital (or finance) lease (for example, a lease of equipment for nearly all of its useful life), the organization that leases the asset—referred to as a “lessee” – would recognize lease assets and liabilities on the balance sheet
If the lease is classified as an operating lease (for example, a lease of office space for 10 years), the lessee would not recognize lease assets or liabilities on the balance sheet
Investors and other financial statement users have historically criticized this model because it does not always provide a faithful representation of an organization’s leasing activities. To remedy this and end what the U.S. Securities and Exchange Commission (SEC) and other stakeholders have identified as one of the largest forms of off-balance sheet accounting, while requiring more disclosures related to leasing transactions, FASB has established new leasing guidelines.
Lease Accounting Changes
Under the new guidance, organizations that lease assets will be required to recognize assets and liabilities for all leases with terms greater than 12 months. For leases with a term of 12 months or less, a lessee can elect not to recognize lease assets and liabilities but then should generally recognize the lease expense on a straight-line basis over the lease term.
The recognition, measurement, and presentation of expenses and cash flows by a lessee will still primarily depend on its classification as a finance or operating lease – just as it does with current GAAP (Generally Accepted Accounting Principals). However, unlike current GAAP, which requires only capital leases to be recognized on the balance sheet, the new ASU will require both types of leases to be recorded in the statement of financial position as (right-of-use) assets and (lease obligation) liabilities.
In addition, disclosures that help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases will now also be required, including qualitative and quantitative information about the amounts recorded in the financial statements.
The ASU on leases will take effect for the following particular groups for fiscal years – and interim periods within those fiscal years – beginning after December 15, 2018:
Not-for-profit entities that have issued securities that are added, listed, or quoted on an exchange or an over-the-counter market
Employee benefit plans that file financial statements with the SEC
For all other organizations, the updated lease standards will take effect for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020.
Once the new ASU takes effect, users of financial statements, including investors, should appreciate more transparent and comparable information about lease obligations. If you have questions about the new lease accounting standards or need assistance with your lease reporting, Hanson & Co. wants to help! Call us at 303-388-1010 or click here to contact us. We look forward to speaking with you!