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FASB New Lease Standard Quick Reference Guide

10/15/2019 - By Margaret Vining, CPA

In February 2016, the Financial Accounting Standards Board (“FASB”) issued the new leasing standard in Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842). The most notable change under the new leasing standard is a lessee will now recognize right-of-use (“ROU”) assets and related lease liabilities on the balance sheet for most leases.

While the standard has already become effective during 2019 for large public companies, FASB has recently voted to delay implementation of the standard for small reporting companies (as defined by the SEC), non-SEC public companies, and private companies to 2021.

To help readers to gain a basic understanding of lessee accounting under the new standard, Saltmarsh, Cleaveland & Gund has assembled a quick reference guide relating to the new standard.

1. Choose method of adoption

There are two different methods of adoption that entities have the option to choose from. The retrospective method applies the new standard to each prior reporting period presented in the financial statements. The cumulative catch-up method is an adjustment made at the adoption date which applies the new standard to all leases existing at the adoption date. The adjustment is a cumulative effect adjustment made to the opening balance of retained earnings. This method was made available to reduce costs and complexity for preparers in implementing the new standard.

2. Identify the lease term

The lease term is the non-cancellable period for which the lessee has the right to use the underlying asset. The lease term should also include any extension/renewal periods if the lessee is reasonably certain to extend. The lease term should also consider any lease termination options if the lessee is reasonably certain to exercise.

3. Determine lease payments

Some of the more common items that should be included in lease payments are the fixed payment (including fixed amounts of property taxes and insurance), variable lease payments that depend on an index (CPI) or rate, and the exercise price for the option to purchase the underlying asset, if reasonably certain to do so. Lease payments should be reduced by any incentives paid or payable to the lessee.

Management will also need to identify the lease and non-lease components. Lease components are related to the right to use underlying asset. Lease components will be used to establish the ROU Asset and Lease Liability on the balance sheet. Non-lease components are any goods or services provided to the lessee that are separate from the right to use the asset (maintenance, security, cleaning, etc.).  Non-lease components will be expensed as incurred on the income statement.

4. Determine the discount rate

If determinable, management should use the implicit rate in the lease.  If the implicit rate cannot be determined, management can use the incremental borrowing rate, which is defined as the rate the lessee would pay for a collateralized borrowing over a similar term. In addition to the two options above, private companies also have the option to elect to use a risk-free rate.

5. Classify the lease

Under the new standard, a lease should be classified as a finance lease if it meets one of the following criteria:

  • Ownership transfers to lessee by end of lease.
  • Lessee is reasonably certain to exercise option to purchase the asset.
  • Lease term is for a major part of asset’s remaining economic life.
  • Present value of lease payments is greater than substantially all of the fair value of the asset.
  • Asset will have no alternative use to lessor at end of lease.

If the lease meets none of the above criteria, it is classified as an operating lease.

6. Initial measurement and recognition (Day 1 Accounting) 

The method to establish the initial lease liability and ROU asset is the same for both types of leases.  The lease liability is established by taking the present value of lease payments not yet made, discounted at rate noted above. The ROU asset is established by taking the Lease Liability on Day 1, plus initial direct costs incurred by the lessee, plus pre-payments of lease payments, less receipts of lease incentives.

7. Subsequent accounting (Day 2 Accounting)

Subsequent accounting will be different depending on whether the lease is considered a finance lease or an operating lease. A general synopsis of the accounting for each type of lease is provided below to illustrate the similarities and differences under the new standard.

If the lease is recorded as a finance lease:

  • Amortize the ROU asset on straight line basis over the lease term.
  • Record interest expense on the carrying value of the lease liability.
  • Reduce carrying value of the lease liability as the lessee makes payments.
  • Record variable lease payments, if any, in the period incurred.

If the lease is recorded as an operating lease:

  • Amortize the ROU asset over the lease term by the difference between straight line lease expense and the liability accretion. Straight line lease expense is the sum of the undiscounted lease payments and initial direct costs, divided by lease term.
  • Accrete the carrying value of the lease liability based on the discount rate.
  • Reduce the carrying value of the lease liability as the lessee makes payments.
  • Record variable lease payments, if any, in the period incurred.

If you have questions or would like additional information on the new lease standards, please email me or call your Saltmarsh advisor at (800) 477-7458.

About the Author | Margaret Vining, CPA
Margaret is a manager in the Audit & Assurance Department of Saltmarsh, Cleaveland & Gund. She is also a part of the firm’s Financial Institution Advisory Group, with particular experience providing audit services to the firm’s financial institution clients. Prior to joining Saltmarsh, she worked in retail banking for several years as a CSR Supervisor, where she dealt specifically with branch operations and staff supervisory functions.

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