Understand and consider the different options available as you review your leases, but…
Private entities subject to the Financial Accounting Standards Board’s (FASB’s) new lease accounting standard ASC 842 may get some deadline relief if a recently proposed effective-date extension becomes final, but implementation can still present a significant challenge regardless of the timeline. In order to make the process as smooth as possible, every affected entity should develop a lease accounting transition policy that includes three key things:
- A materiality threshold
- A plan to determine which FASB “practical expedients” will be used, and
- A plan to determine the appropriate application date.
Note that while we recommend setting a transition date and determining which practical expedients you will adopt as you create your policy, the standard does not require that you determine the application date or expedients at the outset. Final decisions on these can be deferred so that information uncovered during the transition period can be considered. It’s important to understand and consider the different options available as you review your leases, but nothing becomes set in stone until the financial reports are issued.
ASC 842 Materiality Threshold
At the outset, management needs to set a threshold for materiality that helps those working on the transition quickly identify which leases need to be reviewed and which are too small to affect the bottom line. This is important, as it will eliminate immaterial contracts from further review and provide valuable time savings.
Practical Expedients for Lease Accounting
In order to help affected businesses with the transition to a new standard, FASB has approved a number of certain implementation shortcuts known as “practical expedients” that are meant to provide transition relief to entities. If your business is working to conform its financial reporting to the new lease accounting rules, you’ll need to review the list of expedients and determine a transition policy that makes sense for your particular circumstances.
Lease Accounting Practical Expedients 1-3: “The Package”
The first three expedients have come to be known as “the package” because an entity can only elect all three of them together or none at all. They are:
- An entity does not need to reassess whether any expired or existing contracts are, or contain a lease.
- For any expired or existing leases, management does not need to reassess its classification in transition if it was correctly classified under the previous standard (ASC 840).
- An entity does not need to reassess initial direct costs for any existing leases.
These three expedients can save a substantial amount of time at implementation. It is important to note that in order to make this election, an entity must have properly identified and recorded leases under ASC 840.
This practical expedient allows entities to combine amounts attributable to lease and non-lease components into a single lease component for evaluation for existing lease agreements at transition. Under the new rules, costs that aren’t attributable to the right to use the asset should be valued and recorded separately from the lease liability. For instance, if a copier lease includes a routine repair and maintenance agreement, that agreement must now be valued and recorded separately from the liability. Entities can elect to continue treatment of these costs under the previous standard for leases in effect at the time of transition.
If a lease is shorter than 12 months at the lease commencement date and does not contain a purchase option that the lessee is reasonably certain to exercise, the reporting entity can elect not to treat it as a right-of-use asset.
FASB’s expedients include the option to classify a lease at transition based on information that was not available when it was created. This can be helpful for businesses evaluating leases that have an option to extend, but there is a potential downside in that some leases may be reclassified from operating to capital.
The rules permit an entity to continue treating existing or expired land easements in the same manner they were accounted for under the previous standard.
An entity must elect one of two modified retrospective approach methods to apply the transition provisions in the standard. Under the two methods, application date would be:
- The later of
- The beginning of the earliest comparative period presented in the financial statements or
- The commencement date of the lease, OR
- The beginning of the period of adoption.
Consider the Users of Your Financial Statements
For most of the non-public entities covered by FASB’s proposed extension, we recommend working with your accounting advisor to determine the path that gets you through the transition with the least complication. However, it’s important to remember that private entities might be dealing with a specific audience when it comes to financial statements. If a bank or stakeholder regularly relies on your financial statements, it is important to consider their requirements while reviewing your financial statements.
Connect with a Freed Maxick Lease Accounting Specialist
Private companies subject to the ASC 842 transition will likely need lease accounting consulting support in order to comply even if FASB’s proposed extension is finalized.
For more information on how the new lease accounting standard could affect your business, contact Katy Al-Khalidi, CPA at 716.847.2651 for a complementary discussion of your situation and a road-map for compliance.