What You Need to Know about New FASB Lease Reporting Standards

FASB standards for leased property

On February 25, 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update, ASU 2016-02, Leases. For public companies, ASU 2016-02 is effective for fiscal years beginning after December 15, 2018. For all other entities, ASU 2016-02 is effective for fiscal years beginning after December 15, 2019. Early application of the amendments in this is permitted for all entities.

ASU 2016-02 impacts all entities that lease property, plant, or equipment. ASU 2016-02 defines a lease as a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration.

New guidance for operating leases

Currently, operating lease obligations (for example, a lease of office space for 10 years) are disclosed in a company’s financial statement footnotes, but not recorded on the balance sheet. Under the new guidance, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months. This differs from current GAAP, which requires only capital leases to be recognized on the balance sheet, ASU 2016-02 requires both types of leases (finance leases and operating leases) to be recognized on the balance sheet.

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 in current GAAP.

Finance or operating lease?

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 the major part of the remaining economic life of the underlying asset. However, if the commencement date falls at or near the end of the economic life of the underlying asset, this criterion shall not be used for purposes of classifying the lease.
  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 and variable lease payments 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 a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis.
  3. Classify all cash payments within operating activities in the statement of cash flows.

For lessors, the impact of the new FASB regulations is largely unchanged from current GAAP.  For example, the vast majority of operating leases should remain classified as operating leases, and lessors should continue to recognize lease income for those leases  generally on a straight-line basis over the lease term.

Lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. Therefore, companies must apply the guidance at the beginning of the earliest period presented in a set of financial statements for substantially all leases outstanding at initial application.

For additional information on the new FASB lease reporting standards, please contact Simon Filip, KRS CPAs, at (201) 655-7411.