Accounting Standards Update (ASU) 2016-02, Leases (Topic 842) – issued February 25, 2016
For most non-public entities this update is effective for fiscal years beginning after December 15, 2019. However, now is the time to start thinking about longer-term impacts before entering into new leases over the next few years.
Following is an overview, for lessees, of this comprehensive and intricate standard.
How does the standard define a lease?:
- Is there is an identified asset?
- There should be an asset identified in the contract (explicitly or implicitly), and
- The vendor should not have a substantive right of substitution of the asset.
- Do you have control of the leased asset?
- You should have direct use of the leased asset, and
- You obtain substantially all of the economic benefits from directing the use of the leased asset.
Once you have determined that you are a lessee, is it a financing lease or operating lease?
- You have a financing lease if one of the following criteria is met:
- Ownership transfers to you by the end of the lease term, or
- You have an option to purchase the leased asset and exercise of this option is fairly certain, or
- The lease term makes up a majority of the leased asset’s remaining economic life, or
- The sum of the present value of the lease payments is equal to or greater than substantially all of the leased asset’s fair value, or
- The leased asset is so specialized in nature that it is expected to have no alternative use to the lessor at the end of the lease.
- You have an operating lease if:
- None of the above criteria are met.
How do you account for the lease under the new standard?
- Financing Leases:
- In the balance sheet, you will recognize a right-of-use (ROU) asset and a lease liability (initially the present value of the lease payments).
- In the income statement, you will recognize interest on the liability separately from amortization of the ROU asset.
- In the statement of cash flows, you will classify repayments of principal as a financing activity and payments of interest as an operating activity.
- Operating Leases:
- In the balance sheet, you will recognize a ROU asset and a lease liability (initially the present value of the lease payments).
- In the income statement, you will recognize a single lease expense so that the cost of the lease is allocated over the lease term.
- In the statement of cash flows, you will classify all payments as operating activities.
For leases with terms of 12 months or less, you are permitted to adopt an accounting policy electing not to recognize the lease assets and liabilities. Instead, you will recognize lease expense (generally on a straight-line basis) over the life of the lease. If the initial lease term is 12 months or less but there are renewal options, this alternative may not apply.
Please remember this is just a brief synopsis of the complex standard. If you have questions regarding the new lease rules, please contact PBMares.