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Lease Accounting Standard Update Is Getting Closer to Reality

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The FASB issued ASU 2016-02, Leases (Topic 842) in February 2016, and accounting for leases are going to see big changes in the coming years. In an effort to help users of financial statements better understand the rights and obligations associated with lease transactions, improve transparency, and increase comparability of financial statements between companies, the new standards make significant changes to current lease accounting.

One of the largest changes is abandoning capital and operating lease classifications. Under current US GAAP, operating leases are off-balance sheet transactions, recognized as rent expense on a straight-line basis. With the new standards, lessees are required to recognize a ‘right of use asset’ and ‘lease liability’ on the balance sheet. The right of use asset is measured at the present value of future lease payments, representing the company’s right to use an identified asset for a period of time, offset by a corresponding liability.

There will still be two classifications of leases, however – finance and operating. The accounting for these leases is different, as briefly described, below:

  • Finance leases – The right of use asset is amortized over the lesser of the lease life or estimated life of the asset, whichever is shorter, on a straight-line basis. The lease payments will be split between principal payments, which reduce the liability, and interest expense.
  • Operating leases – Entities are to recognize a single lease cost such that the cost of the lease is allocated, straight-line, over the lease term. On payment, the asset and liability are to be reduced by the payment, less an implied interest component of the straight-line expense.

Lease accounting becomes effective for most non-public entities for years beginning after December 15, 2019. Now is a great time to develop an understanding of the new rules and begin building an implementation plan. Consider the effect that the new presentation requirements will have on your balance sheet and key financial ratios.

Your Berntson Porter advisor is available to help you through this transition. You can also refer to the Accounting Standards Update (ASU) at: http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176167901010&acceptedDisclaimer=true