Long Awaited Lease Accounting Standard Issued by FASB

February 26, 2016

After a more than a decade in the evaluation of new lease accounting rules, the Financial Accounting Standards Board (FASB) has finally issued the new lease accounting standard that will create dramatic changes to most companies’ balance sheets.

This new Accounting Standards Update 2016-02 (“ASU”) will take effect for public companies for years beginning after December 15, 2018, and private companies for years beginning after December 15, 2019. Early application will be permitted.

While the concept of a financing or operating lease will continue to exist under the current U.S. Generally Accepted Accounting Principles (GAAP), the major difference is that all leases with terms of more than 12 months in duration will be required to be recorded on the balance sheet (at the net present value of lease payments), both as a “right-of-use asset” and as a liability.

The difference between financing and operating leases is that financing leases will record both an interest component and an amortization of the right-of-use asset, while an operating lease will recognize a single lease cost ratably over the term of the lease. In simple terms, a financing lease is generally considered one that is akin to a purchase and financing of an asset, similar to today’s capital lease concept, whereas an operating lease is considered one that is for use of someone’s asset where there is not an expectation of passage of ownership in the future.

The ASU also will require disclosures that will help financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures will be both qualitative and quantitative, providing additional information about the amounts recorded in the financial statements.

And for Companies that owe bank debt, you can and should be proactive in communication of the impacts of this new standard to your debt financial covenants and we strongly recommend that you don’t wait until the standard becomes effective to have these communications.

The accounting by the lessor will remain largely unchanged from current US GAAP.

The FASB has provided a noteworthy 485 pages in this new standard, including intricacies such as lease provisions for variable payments (such as indexed rentals), options or extension periods, and contracts that provide for non-lease costs in addition to the lease (such as maintenance agreements on leased equipment).

As we continue to fully absorb the effects of this new standard, we will keep you updated on how it will impact your business.