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On February 25, 2016, after nearly 10 years of deliberations and draft proposals, the Financial Accounting Standards Board (FASB) issued ASU 2016-02, its new standard on accounting for leases. Under the new standard, lessees are required to recognize most leases
on their balance sheet, which is a significant change from today’s accounting requirements. This new guidance will affect a significant number of entities across all industries because most companies enter into contracts that are, or contain, leases to support their business operations. The new standard is effective for non-public business entities for periods beginning after December 15, 2019 (i.e., calendar 2020). Early adoption is permitted, though not expected to be widely utilized. Although the mandatory effective date is a few years away, the standard’s modified retrospective transition approach will require entities to reflect the effect of the new guidance in the earliest year presented in the financial statements. Therefore, in the near term, entities should determine what systems and processes they will need to properly adopt the guidance and should begin developing and designing an implementation plan for their transition to the new standard.
The new standard’s scope includes leases of all property, plant, and equipment. At lease inception, a lessee evaluates the terms of a contract to determine whether the contract meets the definition of a lease under the standard and, if so, whether the lease is a finance lease or an operating lease. At initial recognition of the lease, a lessee measures the liability for its lease obligation at the present value of lease payments not yet paid (excluding variable payments) and records the liability, along with a corresponding “right-of-use” asset.
Subsequent adjustments are dependent upon whether the lease is classified as a finance lease or an operating lease. A finance lease results in a front-loaded expense profile with an interest component while an operating lease generally results in straight-line amortization of the right-of-use asset.
The new standard represents a wholesale change to lease accounting. As a result, entities will face significant implementation challenges during the transition period and beyond, such as those related to:
While financial reporting implications may not occur immediately, it is imperative to have a thorough understanding of these changes now when negotiating long-term leases or financing arrangements. Our team is ready and able to assist your organization with this significant transition process.
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