The most significant change brought by Topic 842 is the addition of a “right-of-use” asset and lease liability on the face of the balance sheet for all leases greater than 12 months. Under previous generally accepted accounting principles (GAAP), operating leases did not require the recording of assets and liabilities, but only disclosure in the footnotes to the financial statements. It is essentially moving the commitment from a disclosure item to actual recognition in the statements themselves. FASB’s basic principle and reason for the change boils down to two questions: “who has the right to control the asset?” and “who really benefits from the use of the asset?” By recording the asset and corresponding liability on the balance sheet, you are answering those questions with “my company.”
Moreover, FASB will require increased qualitative and quantitative disclosures in the financial statement footnotes. These disclosures will relate to the nature of the lease, significant judgments and assumptions made by management, lease expense amounts, and maturity schedules. FASB’s objective for these expanded disclosures is to increase the usefulness and comparability of the financial statements for decision makers such as investors, lenders, and other creditors.
In regard to the income statement, recognition and presentation of expenses has not significantly changed from previous GAAP. For financing (previously capital) leases, the expenses will be separated into amortization of the right-of-use asset and the interest on the liability. For operating leases, the single lease cost will be allocated over the lease term, generally on a straight-line basis.
Final implementation for private entities is currently scheduled for fiscal years beginning after December 15, 2019, with early implementation permitted. It seems like a long time from now; however, the new standard will change the accounting for all leases in existence on the effective date, not just new leases.
To prepare for the significant changes, we recommend assessing existing leases and reviewing them for specific provisions that will be affected by the new standard. Additionally, we encourage you to consider the impact that recording new assets and liabilities will have on any current or potential covenants, compensation arrangements, and state and local tax implications. Implementation of this standard may also require companies to reconsider current processes to evaluate and record leases within their accounting software.
The best time to start asking questions is now, while there is still time to prepare. We advise you to take the opportunity to reach out to your accountant, financial statement users, and bankers to discuss the approaching changes to your balance sheets and income statements. You can obtain a copy of the actual standard at www.fasb.org. The FASB site also features a six-minute video describing the reasons for the changes to the lease accounting standards.
To learn more about the changes to lease accounting standards, contact your WK advisor at (573) 442-6171 or (573) 635-6196.