The new accounting standard on leases, issued Feb. 25, 2016, contains some dramatic changes to existing U.S. generally accepted accounting principles. Most prominently, the new guidance alters the way operating leases are accounted for, so that they will be reflected on the lessee’s balance sheet. As a result, balance sheets will be bigger and stakeholders will have a clearer and more complete picture of an organization’s leasing activities and their effects on the financial statements.
The lengthy three-part standard, Accounting Standards Update No. 2016-02, “Leases (Topic 842),” has been in development for several years and its issuance marks the completion of the Financial Accounting Standards Board’s project to overhaul lease accounting.
The standard’s requirements will have a greater impact on some organizations than others, depending on the nature of leasing activities and the structure of existing leases, but almost all organizations are lessees or lessors to some degree. Any entity that engages in lease contracts – for real estate, vehicles, or equipment, for example – will be affected.
Financial and operating executives need to understand how the changes – which include new quantitative and qualitative disclosure requirements – will affect their organizations’ financial modeling and reporting. Then they need to go beyond lease accounting to conceive and execute changes in processes, systems, and controls, so that their organizations can be prepared to adopt the standard by the effective date.
The new accounting standard has multiple effective dates. For public business entities and certain not-for-profit entities and employee benefit plans, it will be effective in interim and annual periods beginning after Dec. 15, 2018. For other entities, the guidance will be effective for annual periods beginning after Dec. 15, 2019, and interim periods within the fiscal years beginning after Dec. 15, 2020. Early adoption is permitted for all entities, and a modified retrospective transition approach is required. The standard includes practical expedients for transition and a framework for applying the rule changes.
To be ready in time, financial executives at organizations with significant leasing activity should consider taking these actions without delay:
- Form an implementation task force.
- Understand and evaluate the transition.
- Evaluate the classification of existing leases under the new lease accounting model
- Assess the financial impact of the new lease accounting model.
- Begin documenting any significant judgments made.
- Consider possible changes to systems, processes, and controls.
- Consider the impact of the coming changes on financial and business practices.
- Consider the tax implications.
Leasing is an important part of the operations of many organizations. For some, leasing provides a means to finance access to assets and minimize exposure to the risks of asset ownership. For organizations serving as lessors, leasing can provide a pathway to a long-term return on investment without having to relinquish ownership of the asset.
Because leases cross over many industries – including real estate, financial services, retail, manufacturing, distribution, aerospace, and transportation – as well as all types of organizations – including not-for-profits and public and private companies – the impact of the new leases accounting standard will be widespread. Preparation can be arduous and time-consuming, but the path to implementation will be smoother for the organizations that are armed and ready.
Read more at www.crowehorwath.com/leases-fei.
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