Accounting Standards Codification (ASC) 842 provides the requirements of financial accounting and reporting for lessees and lessors. On Feb. 25, 2016 the Financial Accounting Standards Board (FASB) published Accounting Standards Update (ASU) 2016-02, Leases, (Topic 842), the long-awaited new standard on lease accounting.
- Increase transparency and comparability among organizations by recognizing the assets and liabilities that arise from nearly all lease transactions
- Provide lenders and other users of financial statements a more useful picture of the long-term financial obligations of companies
- Eliminate off-balance sheet accounting by providing investors and other users of financial statement a better representation of an organization’s leasing activities
Before the update and creation of ASC 842, U.S. Generally Accepted Accounting Principles (GAAP) required only capital leases to be recognized on the balance sheet. With the new guidance, lessees will be required to recognize the following for both capital and operating leases exceeding 12 months:
- A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and
- A right-of-use asset, which represents the lessee’s right to use or control the use of a specified asset for the lease term.
Further, off-balance-sheet leases will have to be brought onto the company’s books, and that may require companies to update their lease systems and processes, as well as their internal controls. Under the new standard, lessor accounting will remain similar to current GAAP, though the new standard contains language that better aligns lessor accounting with the lessee accounting model.
Effective Dates for the New Standard
- Public companies: Fiscal years beginning after Dec. 15, 2018 and interim periods within those fiscal years
- Other organizations: Fiscal years beginning after Dec. 15, 2019, and interim periods within fiscal years beginning after Dec. 15, 2020
- Early adoption is permitted
- Companies should begin preparing now to implement the new FASB standard. At a minimum, they will need to:
- Evaluate their lease portfolios and determine which leases are subject to the new standard
- Determine the need to implement new systems, controls or processes to accommodate the new standard
- Review legal agreements and debt covenants, as those may be impacted
- Discuss the impact with stakeholders (boards of directors, investors, lenders)