by Tyler Mosley, CPA, CFE
Audit Manager at Atchley & Associates, LLP
On February 25, 2016, the Financial Accounting Standards Board (FASB) released accounting standards update No. 2016-02 which amended the Accounting Standards Codification Topic 842, Leases. The previous accounting model for leases in generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) did not require lessees to recognize the assets and liabilities arising from operating leases but it did require lessees to recognize assets and liabilities arising from capital leases. Some users of the financial statements complained that the financial statements of two similar entities could read differently based on whether or not they accounted for their leases as operating leases or capital leases.
FASB decided to address those criticisms by modifying the lessee accounting model in GAAP to require a lessee to recognize assets and liabilities for the rights and obligations created by leases. The new guidance requires a lessee to recognize the lease assets and lease liabilities for all leases with a lease term of more than 12 months. FASB’s goal is to provide a more faithful representation of a lessee’s assets and liabilities and enhance disclosures about a lessee’s financial leverage and its leasing activities.
The proposed standard does not provide for the “grandfathering” of existing leases and would require the new guidance to be applied to all existing lease agreements. Entities with significant lease exposure should reach out to their leasing entity to discuss the impact of having to report all leases with a term greater than 12 months on their balance sheets. Entities with loans with financial institutions should also consider discussing the impact of the new standard on any loan covenant ratios that could affect compliance with debt obligations.
The new lease accounting standards are effective for fiscal years beginning after December 15, 2018 for the following entities:
- A public business entity
- A not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market
- An employee benefit plan that files financial statements with the U.S. Securities and Exchange Commission (SEC)
For all other entities, the standard is effective for fiscal years beginning after December 15, 2019.