The FASB’s lease accounting standard change, ASU 2016-02, Leases (Topic 842), presents changes to the balance sheet of lessees, financial metrics (including debt covenants), and aligns with the new revenue recognition standard. The following is intended to provide an overview of key components of the new standard.
Your Porte Brown team will be working with you on the conversion and necessary changes applicable to your organization to implement the requirements of the new lease standard.
What Is the Impact on the Lessee?
The new standard will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases.
When a lease is recorded, a liability must be recognized based on the present value of future lease payments, with an offsetting entry to recognize a right-of-use (ROU) payment.
What Are the Two Types of Leases?
Finance Lease – The new capital lease.
The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
The lease term is for the major part of the remaining economic life of the underlying asset.
The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments equals or exceeds substantially all of the fair value of the underlying asset.
The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.
Operating Lease – Any Lease other than a financing lease.
Require lease expense to be recognized on a straight-line basis over the lease term.
Both financing and operating leases will be required to be recorded on the balance sheet.
At the commencement date, an entity should determine its total lease payments so that it can assess the payment stream to determine the present value of future minimum lease payments.
There are complexities around what to include or not include as a “lease payment.”
The Lease term should be the sum of the noncancelable period of the lease along with any periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option.
When Is It Effective?
For all nonpublic entities, the ASC 842 goes into effect for annual periods beginning after December 15, 2019, or calendar year 2020 (fiscal year 2021). Early adoption is permitted.
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