In February, the Financial Accounting Standards Board issued an Accounting Standards Update on lease accounting.
The new ASU affects most organizations that have lease contracts. This ASU may have a material impact on the analysis of the balance sheet, income statement and financial ratios.
There is a specific exception for short-term leases, defined as terms for 12 months or less.
For public organizations, the ASU is effective for fiscal years and interim periods within those fiscal years, beginning after Dec. 15, 2018. In other words, for calendar year organizations, it would be effective Jan. 1, 2019.
For all other organizations, there would be a one-year delay, as the ASU is effective for fiscal years beginning after Dec. 15, 2019, and for interim periods within fiscal years beginning after Dec. 15, 2020.
NOT ENOUGH INFORMATION
Why a new leasing standard or ASU?
The federal Securities and Exchange Commission issued a report on off-balance sheet financing which identified leases as a major source of off-balance sheet financing.
The legacy-leasing standard has been criticized for not providing information that users of financial statements desire and a major source off-balance sheet financing.
The goal of the new ASU is to include most leases on the balance sheet while providing information that users of financial statements desire.
Under the new ASU, an organization applies professional judgment to determine the accounting for the lease contract, which uses names that are contained in the legacy-leasing standard:
Some leases would be classified as capital leases (most equipment leases), whereby the lessee would recognize lease assets and liability on the balance sheet and use the effective interest method of amortization interest (similar to a loan).
Other leases would be classified as operating leases (most real estate leases), whereby the lessee would recognize lease assets and liability on the balance sheet and use the straight-line method of amortization interest.
The existing lease standard ASU has been identified for failing to meet the needs of users of financial statements because it does not always provide sufficient information on the leasing transaction.
The new guidance ends what the SEC and others have identified as a major source of off-balance sheet financing, providing more disclosures on leasing contracts and more information that users have been asking for.
John D. Rossi III is a business leader, lecturer, accountant and financial planner with more than 30 years of business and academic experience. An associate professor of accounting at Moravian College in Bethlehem, he is president of JR3 Virtuoso Solutions Inc., specializing in financial reporting, taxation, professional training and consulting services. He can be reached at firstname.lastname@example.org.