By Tyler Williams
As part of their quest to ensure greater transparency in financial reporting, the Financial Accounting Standards Board (FASB) issued a new standard on leases in February 2016 (ASU No. 2016-02). With this new standard, FASB hopes to reduce the amount of off balance sheet operating lease commitments, which the SEC estimated to be $1.25 TRILLION back in 2005. Under the current standard, if a lease meets any one of four criteria, it must be treated as a capital lease and reflected on the balance sheet as a liability and a corresponding capital asset will be recorded. If the lease does not meet any of the four criteria, the lease and underlying asset remains off the balance sheet and all payments are reported as rental expense. These current four criteria will continue to be used under the new standard, as leases will continue to be classified as either operating or finance (capital) leases. However, under the new standard, any lease with a term extending beyond 12 months must be recognized on the balance sheet as a liability based upon the present value of remaining lease payments. A right-to-use asset will also be recognized and amortized over the life of the lease. Therefore, an operating lease with a duration longer than 12 months will make its way onto the balance sheet. Note that the lease will continue to be designated as an operating lease under the new standard. All leases with a duration under 12 months will continue to be expensed over the term of the lease. The new standard also requires additional disclosures to help financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements. The new standard will be effective for publicly traded companies with fiscal years beginning after December 15, 2018. For all other organizations, the standard will be effective for fiscal years beginning after December 15, 2020. Early implementation is permitted.
Not to be outdone, the Governmental Accounting Standards Board (GASB) also issued an exposure draft related to leases in February 2016. GASB opted to use a single model for leases which will eliminate the need to classify a lease as capital or operating. All leases with terms extending beyond 12 months will require the recognition of a lease liability and an intangible right-to-use lease asset. The lease liability will be reduced as payments are made and an expenditure for interest on the liability will be recognized. The right-of-use asset would be amortized over the shorter of the lease term or the useful life of the underlying asset. Leases with terms under 12 months will require the leasee to recognize lease payments as expenditures, much like operating leases under the current standards. This standard also requires additional disclosures about each lease. This new standard has not yet been issued, and a public hearing was held in June 2016. When the standard is issued, it will be effective for reporting periods beginning after December 15, 2018.
While we may be a few years away from the effective dates of these new standards, now is the time to begin reviewing lease agreements and planning for the addition of a few new liabilities and assets on the balance sheet. Below are links to from FASB and GASB with helpful information concerning the new lease standards.
http://www.fasb.org/jsp/FASB/Page/BridgePage&cid=1351027207574#section_1
http://gasb.org/cs/ContentServer?c=GASBContent_C&pagename=GASB%2FGASBContent_C%2FGASBNewsPage&cid=1176167855248