Accounting Standards Update

ASU 2016-02, Leases (ASC 842)

FASB decided to adopt a lessee accounting model that distinguishes between two types of leases, classifying leases as operating leases or finance leases in a similar manner to the requirements for distinguishing between operating leases and capital leases under the old lease accounting standards.

A lessee shall classify a lease as a finance lease when the lease meets any of the following criteria at lease commencement:

  1. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
  2. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
  3. The lease term is for a major part of the remaining economic life of the underlying asset.
  4. The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments equals or exceeds substantially all of the fair value of the underlying asset.
  5. The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

For finance leases, a lessee is required to do the following:

  1. Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the balance sheet.
  2. Recognize interest on the lease liability separately from amortization of the right-of-use asset in the income statement.
  3. Classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability within operating activities in the statement of cash flows

For operating leases, a lessee is required to do the following:

  1. Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the balance sheet.
  2. Recognize lease expense which is calculated over the lease term on a straight-line basis in the income statement.
  3. Classify all cash payments within operating activities in the statement of cash flows.

Lessees and lessors are required to recognize and measure leases using the modified retrospective approach.

KRS professionals are available and happy to assist with any questions or the implementation of the new ASC 842 standards. Visit the KRS Assurance Services page for expanded details. Please contact us if you have any questions or need further assistance.