FASB ACCOUNTING STANDARDS UPDATE
Current Lease Guidance
The FASB’s current lease accounting guidance in Accounting Standards Codification (ASC) 840 - Leases,
calls for both lessees and lessors to classify leases as either capital or operating in their financial
statements depending on certain criteria. Under ASC 840 capital leases are carried on-balance sheet by
lessees, while operating leases are off-balance sheet for lessees.
Background
The FASB and the IASB (the Boards) jointly undertook a lease accounting project with several objectives
in mind, including: to reduce complexity in lease accounting; eliminate arbitrary accounting differences
for transactions that are economically similar; require lessees to recognize all leases on-balance sheet;
and to develop converged lease accounting requirements.
Proposed Changes to Lease Guidance
The proposed FASB Accounting Standards Update (ASU), Leases, and the IASB Exposure Draft with the
same title, are the result of a joint effort to develop a single approach to lease accounting that would
ensure that all assets and liabilities arising from lease contracts are recognized on the balance sheet.
The proposed guidance would affect substantially all leases, except leases of intangible assets, biological
assets, or non-regenerative resources.
Among the key provisions, the proposed guidance would establish a right-of-use (ROU) model to account
for all leases within the scope of the proposed guidance. Under this model, a lessee would recognize
an asset for its right to use the leased asset for the lease term and a liability to make lease payments. A
lessor that retains exposure to significant risks and benefits associated with the underlying asset would
apply a performance obligation approach; otherwise, a derecognition approach would be applied.
Under the performance obligation approach, the lessor would continue to recognize the underlying
asset, but would also be required to recognize an asset for its right to receive lease payments and a lease
liability. Under the derecognition approach, the lessor would derecognize the underlying asset that it
transfers to the lessee and would recognize an asset for its right to receive lease payments. The lessor
would also recognize a residual asset for its rights to the underlying asset at the end of the lease term.
The proposed ASU defines a “lease” as “a contract in which the right to use a specified asset (the
underlying asset) is conveyed, for a period of time, in exchange for consideration.”
EXECUTIVE SUMMARY
PROPOSED LEASE ACCOUNTING CHANGES: ASC 840
Under the proposed guidance, an entity would be required to determine, at the date of inception,
whether a contract is, or contains, a lease, similar to the current requirement in FASB ASC 840, Leases.
To make that determination, an entity would assess whether (1) the fulfillment of the contract depends
on providing a specified asset or assets to an entity and (2) the contract conveys the right to control the
use of a specified asset to an entity for an agreed period of time.
www.SolomonEdwards.com
Proposed Lease Accounting Changes: ASC 840
Key Changes Impacting Lessees
The FASB’s proposed guidance includes a dual approach for the lessee’s accounting for leases. In most cases a
lessee would account for existing capital leases as Type A leases. Type A leases require the lessee to recognize
front-loaded expense made up of interest on the lease liability and amortization of the right-of-use (ROU) assets.
Current operating leases would generally be classified as Type B leases and result in the lessee recording lease
expense on a straight-line basis over the lease term. Both Type A and Type B leases result in the lessee recording a
ROU asset and a lease liability on the balance sheet.
A lessee would do the following:
1. For all leases, recognize a ROU asset and a lease liability, initially measured at the present value of lease
payments (except if a lessee elects to apply the recognition exemption for short-term leases).
2. For Type A leases, subsequently measure the lease liability on an amortized cost basis and amortize the ROU
asset on a systematic basis that reflects the pattern in which the lessee expects to consume the ROU asset‘s
future economic benefits. The lessee would present the unwinding of the discount on the lease liability as
interest separately from the amortization of the ROU asset.
3. For Type B leases, subsequently measure the lease liability on an amortized cost basis and amortize the ROU
asset in each period so that the lessee would recognize the total lease cost on a straight-line basis over the
lease term. In each period, the lessee would present a single lease cost combining the unwinding of the
discount on the lease liability with the amortization of the ROU asset.
Key Changes Impacting Lessors
The FASB decided that a lessor should determine the classification of their leases (as either Type A or Type B) on
the basis of whether the lease is a financing or sale, as opposed to an operating lease. This determination would
be made by the lessor after consideration of whether the lease transfers substantially all of the risks and rewards
incidental to ownership of the underlying asset.
A lessor would do the following:
1. For Type A leases, derecognize the underlying asset and recognize a lease receivable and a residual asset.
The lessor would recognize both of the following:
a. The unwinding of the discount on both the lease receivable and the residual asset as interest income
over the lease term
b. Any profit relating to the lease (as described in paragraph 842-30-30-7) at the commencement date.
2. For Type B leases (and any short-term leases if the lessor elects to apply the exemption for short-term
leases), continue to recognize the underlying asset and recognize lease income over the lease term, typically
on a straight-line basis.
Short-term Leases
The FASB noted it will continue with the recognition and measurement exemption for a lessee’s short-term leases.
Short-term leases have no purchase options and a maximum term, including renewal options, of 12 months or less.
www.SolomonEdwards.com
Proposed Lease Accounting Changes: ASC 840
2
Disclosure
The Boards have stated their objectives for lease disclosure are to help readers of financial statements to understand
the amount, timing, and uncertainty of lease cash flows. The proposed guidance would require companies to
identify the lease agreements under the new definition of a lease, as well as document the relevant data from
the leases including lease term and purchase options in order to determine whether the leases are Type A, Type
B, or qualify for the short-term lease exemption, and to help measure the amount of assets and liabilities to
be recorded in the financial statements. These lease assets and liabilities generally would be measured at the
discounted present value of the fixed lease payments over the estimated lease term.
Transition
Under the FASB’s proposed guidance a modified retrospective transition by lessees is required for all capital and
operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the
financial statements (date of initial application). There is no transition accounting needed for leases that expired
prior to the date of initial application.
The FASB will permit a lessee (as well as lessors) to elect certain specific reliefs, which must be elected as a package
and must be applied to all of a lessee’s leases (not on a lease by lease basis), including:
• A lessee need not reassess whether any expired or existing contracts are or contain leases;
• A lessee need not reassess the lease classification for any expired or existing leases;
• A lessee need not reassess initial direct costs for any existing leases (meaning, whether those costs would
have qualified for capitalization under the new lease standard).
Key Differences between FASB and IASB Proposed Guidance
The IASB opted for a single model approach where lessees will account for all leases, other than short-term leases,
as Type A leases. Additionally, the IASB has opted to given lessees an option to apply either a fully retrospective
approach or a modified retrospective approach upon transition.
Potential Challenges in Adopting Proposed Guidance
The proposed lease accounting changes as they are currently written will have an impact across all industries.
For companies that lease large dollar value equipment, they can see a significant increase in assets and liabilities
as nearly all leases would be brought on-balance sheet. Other entities that have a large number of small dollar
value leases can find adoption of the new guidance to be time consuming and costly as they identify all leases and
related data needed to apply the new rules.
With the majority of leases being recorded on-balance sheet under the proposed guidance, this will impact
various financial metrics including debt covenants. It will be important to determine whether their covenants are
calculated based on “frozen GAAP” measures or based on newly adopted accounting standards.
The proposed guidance will require a new level of judgments and estimates to be made to help identify, classify
and measure leases. These judgments and estimates relate to the determination of whether a lease exists in an
agreement, the lease classification tests, and determination of whether renewal periods and purchase options
exist. These judgments and estimates will need to be reassessed at each reporting period.
www.SolomonEdwards.com
Proposed Lease Accounting Changes: ASC 840
3
How to Prepare?
Now is a good time to start planning as the updated standard can have a significant impact on a company, both
in terms of time and money to implement. To start these efforts, a company should consider making a detailed
listing of all current leases (both capital and operating) to help understand their lease terms and consider how the
accounting may change under the new standards. It is also important to consider the impact of any new leases
signed before the new standards are issued, as such leases will be subject to the guidance when issued.
Companies need to assess whether they have the right level of staff involved in their lease accounting or whether
more senior level staff should be involved going forward to ensure compliance with the proposed guidance.
Companies will no longer be able to setup a lease amortization spreadsheet and carry it forward due to the
complexity of the proposed guidance.
Nonpublic Company Considerations
The FASB decided there will not be alternative recognition, measurement, disclosure, presentation, or transition
guidance provided for nonpublic companies reporting under GAAP, with the exception for the practical expedient
to allow the use of a risk-free rate to measure lease liabilities.
Next Steps in the Process
On November 11, 2015, the FASB deliberated the effective date for the proposed new leasing standard. Expected
to be issued early 2016, the leasing standard will be effective for calendar year-end for public business entities
beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption
permitted. For all other entities, the leasing standard will be effective for fiscal years beginning after December 15,
2019, and interim periods within fiscal years beginning after December 15, 2020. The IASB previously voted for an
effective date of January 1, 2019, but unlike the FASB, the IASB placed conditions on early adoption.
About SolomonEdwards
SolomonEdwards is a national professional services firm focused on strategy execution. We create success for our clients
by providing extensive experience, deep subject matter expertise and adaptability within ever-changing business dynamics.
Through our business consulting division we execute on custom solutions to solve clients’ critical business issues related to
business transformation, accounting and finance, governance and regulatory compliance and mergers and acquisitions.
SolomonEdwards’ Accounting & Finance services help companies to balance the high demands placed on accounting and
finance departments with effective and efficient controls and processes. From general ledger transaction processing and
business process improvement, to plant and cost accounting, financial reporting and financial system assessment and
optimization, our advisors ensure your team is fully aligned and operating at the most efficient levels possible.
For more information, please contact your local SolomonEdwards office:
Atlanta P 404.497.4141 | Chicago P 312.466.0101 | Houston P 713.960.8880 | New York P 212.545.9500
Philadelphia P 610.902.0440 | San Francisco P 415.391.1038 | Washington, D.C. P 703.738.9600
www.SolomonEdwards.com