The Financial Accounting Standards Board (FASB) released Accounting Standards Update No. 2016-02, Leases (ASC 842) on February 25, 2016, effectively eliminating off-balance sheet financing in the form of operating lease arrangements. ASC 842 requires all leases over one year in length to be reported on the balance sheet as both lease assets and lease liabilities as of the effective date of the standard.
The effective date of application for this standard for a publicly traded company and not-for-profit organizations that have issued or are a conduit bond obligor for securities that are traded is December 15, 2018. For non-public companies (and not-for-profit organizations that do not meet the limited requirement in the previous sentence), application is effective for calendar year-end organizations beginning December 15, 2019 and after, and for organizations with a fiscal year-end beginning December 15, 2020 and thereafter. For both public and non-public companies, early application of the standard is allowed.
Subsequent to issuance of the new standard, various organizations analyzed the impact of the new standard and identified two significant concerns surrounding the guidance as issued:
The first concern related to the requirement that an entity retrospectively adopt the standard. Upon initial adoption of ASU 2016-02, an entity was to apply the standard at the earliest period presented in the financial statements, which at the time was January 1, 2017 for publicly traded businesses. This meant that companies with operating leases ending prior to the initial adoption date of the standard were required to conform those leases to the requirements of ASC 842, resulting in substantial administrative burdens associated with implementation.
The second concern related to the requirement of lessors to review lease contracts and separate the lease and non-lease components of each contract, accounting for the components of each lease contract differently. The lease components were required to be accounted for and presented in accordance with ASC 842 while the non-lease components were required to be accounted for and presented in conformity with ASC 606, Revenue from Contracts with Customers.
Due to the costs associated with these concerns, the FASB issued ASU 2018-11 on July 30, 2018. This update centered on reducing the administrative burden identified by entities during implementation of the standard. As a result, entities are no longer required to apply ASC 842 retrospectively. Instead, in the year of implementation, the entity should recognize the cumulative effect of these changes to the opening balance of retained earnings (or net assets). In addition, disclosures in the notes to the financial statements would follow ASC 840 for all periods previous to the current period, the current lease accounting standard until ASC 842 supersedes it. Under this approach, the note disclosure requirements of ASC 840 must be applied to periods which precede the first year of application of ASC 842, meaning the presentation of future minimum lease payment tables for the next five years of both capital and operating leases in the financial statement notes is required.
Secondly, ASU 2018-11 agrees lessee and lessor accounting by no longer requiring lessors to segregate the lease and non-lease components of a contract, and account for them separately, given that two requirements are met:
- The timing and pattern of transfer of the non-lease components and the associated lease components are the same, and
- The lease component, if accounted for separately, would be classified as an operating lease.
To understand the change, it is important to identify which components would be lease and non-lease. Examples of expected lease components would be the monthly lease payment paid and the security deposit paid under lease. Examples of expected non-lease components would be service and maintenance contracts associated with a given lease contract. Under ASU 2018-11, as long as the non-lease components of a lease contract would be accounted for under the new revenue recognition standard ASC 606 the components may both be reported together under ASC 842.
In part two of this series, the application of ASC 842 will be discussed. Stay tuned for further discussion on the lease accounting topic from Rubino & Company, Charted, certified public accountants and consultants providing expertise and solutions for government contractors, nonprofits, public housing authorities and state and local governments nationwide.
Karis is a manager in Rubino & Company’s audit practice. Her experience includes supervising and managing audit, review and compilation engagements for a wide range of clients, including nonprofit organizations and government contractors. She oversees all phases on on-site audit working including planning, fieldwork and financial reporting.
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