Accounting Standards Update No. 2016-02 Leases (Topic 842)

Leases

"Contractual arrangements by which a lessor (owner) provides a lessee (user) the right to use an asset for a specified period of time."

Organizations are frequently faced with the option to buy or lease assets to achieve their business goals.

Capital Leases

The arrangement must be non-cancelable and meet at least one of the following four criteria

  • The agreement specifies that ownership of the asset transfers to the lessee.
  • The agreement contains a bargain purchase option.
  • The non-cancelable lease term is equal to 75% or more of the expected economic life of asset.
  • The present value of the "minimum lease payments" is equal to or greater than 90% of the fair value of the asset."

Operating Leases

Any lease that is not a capital lease is considered an operating lease.

Previous Accounting Standards

Capital leases show up on the balance sheet and the income statement.

At inception
At payment dates

Previous Accounting Standards

Operating leases are seen on the income statement and in the disclosure notes.

At payment dates
At the end of each year

Why do we need new standards?

  • Operating leases do not show up on the balance sheet.
  • Errors can be introduced in assumptions and estimates.

In 2005, the SEC encouraged the FASB to begin working on revising the lease standards.

ASU No. 2016-02

  • Accounting Standards Update No. 2016-02 was issued on February 25, 2016.
  • The definition of a lease and the criteria for classifying leases have stayed the same.
  • The biggest change is in the "critical determination" of the lease.

ASU No. 2016-02

  • Organizations must identify and classify their leases, and account for both capital and operating.
  • The accounting varies slightly based on classification.

Step 1: Recording the Asset and Liability

Record the asset and liability at the present value of the lease payments.

Step 2: Recording Payments

Capital Leases

  • Interest on lease liability and amortization of the asset are recorded separately on the statement of comprehensive income.
  • Statement of Cash Flows: repayments of principal are recorded in the finance section, interest and variable lease payments are recorded in the operating section

Operating Leases

  • A single lease cost recorded on a straight-line basis.
  • Statement of Cash Flows: all cash flows are recorded in the operating section.

Additional Changes

  • Short-term leases have freedom in accounting principle.
  • Disclosures are qualitative and quantitative.
  • Lessee accounting has only experienced small changes (definitions, revenue recognition).
  • GAAP vs. IFRS

Implications for Implementation

The update is effective beginning December 15, 2018 for the majority of organizations.

Things to consider when implementing the new standards.

  • Update Lease Inventories
  • Transparency
  • Identify Cost Savings
  • Different Rules

Accounting Standards Update 2016-02, Leases (Topic 842), provides users of financial data with a transparent and comparable view of leases, and bring positive change to accounting for such obligations.

References

Fafatas, S., & Fischer, D. (2016). The Effect of the New Lease Accounting Rules on Profitability Analysis in the Retail Industry. Journal of Corporate Accounting & Finance,28(1), 19-31. doi:10.1002/jcaf.22206

FASB. (2016, February 25). Update 2016-02-Leases (Topic 842) Section A-Leases: Amendments to the FASB Accounting Standards Codification®. Retrieved February 22, 2017, from http://fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176167901010&acceptedDisclaimer=true

James, M. L. (2016). ACCOUNTING FOR LEASES: A CASE EXPLORING THE EFFECT OF THE NEW LEASE ACCOUNTING STANDARD ON THE FINANCIAL STATEMENTS. Journal of the International Academy for Case Studies, 22(3), 152-157. Retrieved from http://ezproxy.liberty.edu/login?url=http://search.proquest.com/docview/1847565650?accountid=12085

NEW FASB LEASE ACCOUNTING GUIDANCE MOVES MOST LEASES TO BALANCE SHEET. (2016). Bank Auditing and Accounting Report, 49(6), 1-2. Retrieved from http://ezproxy.liberty.edu/login?url=http://search.proquest.com/docview/1788219142?accountid=12085

Rosenhouse, M. A., Esq. (2016). FASB UPDATES LEASING STANDARDS, CREATING NEW CODIFICATION TOPIC. SEC Accounting Report, 42(5), 1-3. Retrieved from http://ezproxy.liberty.edu/login?url=http://search.proquest.com/docview/1783997105?accountid=12085

Spiceland, J. D., Sepe, J. F., Nelson, M. W., & Thomas, W. B. (2016). Intermediate Accouting (8th ed.). New York, NY: McGraw-Hill Education.

Tysiac, K. (2016, January 12). IASB issues leases standard; FASB to follow. Retrieved February 22, 2017, from http://www.journalofaccountancy.com/news/2016/jan/iasb-issues-leases-standard-201613694.html

Tysiac, K. (2016, February 25). New FASB Leases Standard Brings Transparency to Lessee Balance Sheets. Retrieved February 22, 2017, from http://www.journalofaccountancy.com/news/2016/feb/fasb-issues-leases-standard-201613941.html

Tysiac, K. (2016, February 26). How to Comply with the New Leases Standard. Retrieved February 22, 2017, from http://www.journalofaccountancy.com/news/2016/feb/how-to-comply-with-new-leases-standard-201613910.html

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