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Major Shift in Lease Accounting Could Cause Major Headaches

By MarksNelson on March 1, 2016 in Articles, Assurance Services, Brandi DiGiorgio CPA CGMA

For decades, companies weren’t required to report many lease-related assets and liabilities on their balance sheet. That’s all about to change under a new lease accounting standard that was issued on February 25, 2016, Accounting Standards Update No. 2016-02, Leases (Topic 842).

Historically, companies have been required to record lease obligations on their balance sheet if the lease is considered a financing arrangement, such as rent-to-own contracts for buildings or vehicles.  Companies must also consider various rules to determine if they have a capital lease. If the conditions are met for capital lease treatment, the lessee must report the lease on the balance sheet as a capital lease. If the conditions aren’t met, the lease is generally considered an operating lease and the lessee simply records the payments as expenses on the income statement.

Financial Accounting Standards Board’s recent release changes the way these obligations are reported. It is the result of converging with an international standard with the same name that provides for more transparency on the balance sheets for commitments.  Currently, the terms of operating leases have only been required to be disclosed in notes to the financial statements. Under the new guidance, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months.  Currently, the classification of expense and cash flows from a lease by lessee primarily depends on its classification as a capital lease or operating lease.  However, the new guidance will require both types of leases to be recognized on the balance sheet.  The new guidance also will require additional qualitative and quantitative disclosures to help investors and other financial users better understand the financial impact of these leases.  This will likely have an impact on financial ratios that are measured internally and externally.  Financial requirements for bank financing will need to be reviewed to ensure there aren’t any surprises when this standard takes effect.

The accounting by organizations that own the assets leased by the lessee – also known as lessor accounting – will remain largely unchanged from current Generally Accepted Accounting Principles (GAAP).

For private companies, the guidance is effective for fiscal years beginning after December 15, 2019.

To find out more information on the new lease accounting standard contact your MarksNelson professional at 816-743-7700.