Background

Leasing is widely use to address a variety of business needs, from short-term asset use to long-term asset financing.  Sometimes leasing is the only option available to obtain the use of a physical asset (such as office space).  Leasing transactions today represent over $1.4 trillion in off balance sheet financing.  Because of its magnitude, many have argued that the disclosures prior to the new pronouncement were inadequate.

The FASB and IASB initiated a joint project on leases in 2006 as part of the global convergence effort.  After issuing two exposure drafts, extensive outreach and re-deliberations to address the concerns raised by stakeholders, the FASB and IASB issued separate lease accounting standards that diverged in significant areas.

Key Provisions

The main difference between previous GAAP and ASC 842 is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP.  The FASB reached the conclusion that the economics of lease transactions may be different between leases and therefore ASC 842 retains a distinction between finance leases and operating leases.  The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from previous GAAP.  The principal difference from previous guidance is that the lease assets and lease liabilities arising from operating leases should be recognized in the statement of financial position.

The core principle is that a lessee should recognize the assets and liabilities that arise from leases.  A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.  When measuring assets and liabilities arising from a lease, a lessee (and a lessor) should include payments to be made in optional periods only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease.  Similarly, optional payments to purchase the underlying asset should be included in the measurement of lease assets and lease liabilities only if the lessee is reasonably certain to exercise that purchase option.

For finance leases, a lessee is required to do the following:

  1. Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position
  2. Recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of comprehensive income
  3. Classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows.

For operating leases, a lessee is required to do the following:

  1. Recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position
  2. Recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis
  3. Classify all cash payments within operating activities in the statement of cash flows.

Effective Dates

The new lease accounting pronouncements are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, for any of the following:

  1. A public business entity;
  2. A not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over the-counter market; and,
  3. An employee benefit plans that files financial statements with the U.S. Securities and Exchange Commission (SEC).

For all other entities, the amendments to the lease accounting rules are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.

Early application of the amendments in this update is permitted for all entities.

Additional Resources

Exhibits I and II – an example of the accounting treatment of an operating lease and an example of the accounting treatment for a finance lease.

Exhibit III – a series of questions and answers concerning the new pronouncement.

FASB video on lease accounting

Exhibit IV – next steps slide from the luncheon presentation.