Lease Accounting – FASB Has Finalized the Effective Date

By Baker Newman Noyes January 8, 2016

On November 11, 2015, the FASB established the effective date for the proposed new lease accounting standard, which has been in the works since the original exposure draft was released in 2010, and is expected to be issued in the first quarter of 2016.

For public business entities, the final standard will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. For December 31 public companies, this means an adoption date of January 1, 2019 with a retrospective application. For nonpublic entities, the final standard will be effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. For December 31 nonpublic companies, this means an adoption date of January 1, 2020 with a retrospective application. Early adoption will be allowed for all entities upon the issuance of the final standard which the FASB is working to issue early 2016.

As a reminder, understanding this standard and its impact is important as companies with significant leases (with terms that exceed twelve months) are most likely going to experience a significant increase in assets (relating to right-to-use assets) and liabilities. In light of these increases, many debt agreements will need to be changed as the significant increase in assets and liabilities will have a meaningful impact on debt covenants. Additionally, expense recognition will depend on the nature of the underlying asset and whether the lessee acquires or consumes more than an insignificant portion of the underlying asset. The standard’s draft includes a “dual model” whereby leases will either be Type A or Type B. If the lessee is expected to consume more than an insignificant portion of the asset over the lease term, then it is a Type A lease; if less, than it is a Type B lease. As a practical expedient, the standard’s draft contains a rebuttable presumption that leases of property (i.e. land and/or buildings) are Type B leases, and leases of assets other than property (i.e. equipment) are Type A leases. For Type A leases, lessees will recognize lease costs by separately recognizing amortization expense for the right-of-use asset and interest expense for the unwinding of the discount on the lease liability. For Type B leases, lessees will recognize a single lease cost that recognizes the amortization of the right-of-use asset and the unwinding of the discount on the lease liability using the straight-line method.

Accounting by lessors will be based on similar concepts with most leases of assets other than property classified as Type A leases and most leases of property classified as Type B leases. For Type A leases, the lessor will derecognize the underlying asset on its balance sheet and recognize a right to receive lease payments (a lease receivable) and a residual asset representing the rights that the lessor retains in the underlying asset. Interest income will be recognized for the unwinding of the discount on the lease receivable and the residual asset as interest income over the lease term with any profit relating to the lease recognized at the commencement date. For a Type B lease, the lessor will continue to recognize the underlying asset and will generally recognize lease income over the lease term on a straight-line basis.

Now that the uncertainty of the effective date is eliminated, companies should finalize a plan to ensure a seamless transition upon adoption of the new standard. Companies should considering evaluating the impact (taking into account the retrospective application requirement) relating to existing leases. Consideration should be given to creating a lease database which catalogs existing leases and the pertinent information and assumptions that will be needed to calculate the lease obligation such as the lease term, renewal options, and payments. Depending on the number of leases and the availability of lease information, this could be a time consuming effort. Not only could the creation of a database take a considerable amount of time, the ongoing maintenance could as well, and therefore, companies will also need to consider the impact of the adoption of this accounting standard on their resources and processes.

If you would like to discuss further, please contact your BNN advisor at 800.244.7444