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FASB Releases ASU No. 2016-02, Leases (Topic 842)

February 26, 2016

On Feb. 25, 2016, the Financial Accounting Standards Board (FASB) released Accounting Standards Update No. 2016-02, Leases (Topic 842) (the Update). Previous lease accounting guidance has long been criticized for not addressing the needs of financial statement users and FASB has spent several years on this project to address the concerns of users. Since all entities that enter into leases will be impacted by the Update, the provisions will have a wide-reaching impact on financial statements.

The key difference between the previous guidance and the Update is the recognition of a right-to-use asset and lease liability on the statement of financial position for those leases previously classified as operating leases under the old guidance.

The Update maintains two classification of leases:

  1. Finance leases (which replaces capital leases)
  2. Operating leases

The criteria used to determine such classification is essentially the same as under the previous guidance, but it is more subjective. The lessee would classify the lease as a finance lease if any of the following criteria at lease commencement are met:

  • The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
  • The lease grants the lessee an option to purchase the underlying asset the lessee is “reasonably certain” to exercise.
  • The lease term is for the major part of the remaining economic life of the underlying asset.
  • The present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset.
  • The underlying asset is of such specialized nature that there is no expected alternative use to the lessor at the end of the lease term.

Implementation of the Update will primarily impact the statement of financial position. It does not include provisions that would significantly impact the statements of operations or cash flows.

Key accounting provisions for each lease classification are included below.

Finance Leases Operating Leases
Statement of Financial Position Right-of-use asset
Lease liability
Right-of-use asset
Lease liability
Statement of Operations Amortization expense of right-of-use asset

Interest expense

Single lease cost, generally on the straight-line basis
Statement of Cash Flows: Operating Activities Interest expense All cash payments
Statement of Cash Flows: Financing Activities Principal payments on Lease liability None

For short-term leases of 12 months or less, lessees are permitted to make an accounting election by class of underlying asset not to recognize right-of-use assets or lease liabilities. If the alternative is elected, lease expense would be recognized generally on the straight-line basis over the respective lease term.

Accounting by lessors was not significantly impacted by the Update. Changes to lessor accounting focused on conformance with certain changes made to lessee accounting and the recently released revenue recognition guidance.

The Update is effective for fiscal years beginning after Dec. 15, 2018, for any of the following:

  • 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

The Update is effective for all other entities for fiscal years beginning after Dec. 15, 2019.

A modified retrospective approach will be used for implementation. The approach includes optional practical expedients primarily focused on leases that commenced before the effective date of the Update, including continuing to account for leases that commence before the effective date in accordance with previous guidance, unless the lease is modified.

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