Both FASB (Financial Accounting Standards Board) and IASB (International Accounting Standards Board) understood the enormity both from the perspective of effort and impact of the implementation of the new lease accounting standards – ASC 842 and IFRS 16.
The adoption of the new standards by entities in general but lessees, in particular, is seen as a very onerous task requiring significant resources, time and critical decision making that impacts an organisations ability to meet its compliance objectives. The boards have issued periodic updates to the respective standards and these Accounting Standards Updates (ASUs) to not only add clarity but importantly, to provide relief for preparers/lessees adopting the new standards through the announcement of amendments.
Created to simplify the transition to the new ‘leases standard’, the boards published certain reliefs in the form of “expedients and exemptions” which are individual measures, that can be taken or ignored. However, whilst designed as accounting reliefs, potential transitioners to ASC 842 should show caution in rushing to adopt them. The aim was that careful use of available expedients would reduce the effort and lessen the impact of implementing the standard. While generally shadowing each other, it is worth noting that the “low-value asset exemption” available under IFRS 16 is not offered under ASC 842.
The use of any expedients or exemptions will need to be disclosed in the financial statements but they may be appropriate, and benefits may accrue through their use. Electing to adopt them and correctly applying them may save your business time and resource as ASC 842 is implemented and compliance achieved.
Short Term Lease Exemption
Offering a straightforward alternative to help resolve one of the more complex requirements of placing an operating lease on the balance, this expedient allows private companies to set the discount rate, if not known, as their risk-free interest rate in either of these two circumstances:
- Rather than calculating the applicable incremental borrowing rate (IBR) or
- Where the lease contract has no implicit discount rate
The obvious benefit is a valuable saving in time and resource but as the risk-free interest rate is typically very low, the result of using it may be a higher liability on the balance sheet.
While some companies will have accounted for land easements as intangible assets others may have accounted for the easements as leases. The complexity would increase where there were multiple land easements and so to simplify the accounting for them under the new standard this practical expedient gives companies, who previously did not account for them as leases, the option to not apply the new leases guidance to land easements that existed prior to the effective date of the new standard. Nevertheless, for land easements entered into or modified on or after the effective date, the new leases guidance regarding easements must be applied.
Further Practical Expedients available under ASC 842
The expedients explained above are all individual and stand-alone in that a lessee can elect to use any or all of them. However, if opted for, this last set of expedients must be taken as a package. Applying to lessees and lessors alike, if this package is adopted, the real saving and tangible benefit is that there is no requirement to reassess the Initial Direct Costs of existing leases on adoption of ASC 842. The three expedients, which come as a package, all relate to leases that are extant at the adoption of ASC 842 -
- Making the presumption that companies are already accounting for leases correctly under ASC 840, lease contracts do not have to be reassessed as to whether they contain a lease. This addresses the issue of “Embedded Leases”.
- Assuming there were no classification errors under ASC 840 then, under the second expedient, companies need not reclassify leases – if they were operating leases under ASC 840 they can remain operating leases under ASC 842. Likewise, existing capital leases remain capital leases though under ASC 842 they will now be referred to as “finance leases”.
- Previously under ASC 840, an entity could allocate the internal costs of acquiring a lease to Initial Direct Costs. Under ASC 842, Initial Direct Costs are now defined as costs that would not have incurred had a lease not been acquired - typically external costs. The third and final practical expedient in this package negates the requirement to reassess any Initial Direct Costs in existing leases – initial direct costs capitalized under ASC 840 also qualify to be capitalized under ASC 842. However, although under ASC 840 a company could allocate a portion of internal expenses — such as salaries for internal real estate staff — to initial direct costs, ASC 842 defines initial direct costs as costs incurred only because a lease contract was entered into, such as broker fees or external legal costs.
- Determine the lease term based on the likelihood of exercising lessee options to extend or terminate a lease or to purchase the underlying asset and
calculate the present value of the fixed payments without having to perform an allocation to the lease and non-lease components.
Additionally, there is the flexibility to apply or not apply the expedient according to the class of underlying asset – it may prove sensible to apply the expedient to all real estate leases but not equipment leases, where the class of asset makes evaluating lease and non-lease components (such as maintenance) easier to determine.
Flexible as this expedient is, it must be applied consistently across similar non-lease components.
adopting the new standard on January 1, 2020, need to recognize and measure any leases on their portfolio as of January 1, 2018, in their comparative financial statements. This practical expedient gives lessees the option to apply the new guidance at its effective date (in this case January 1, 2020) simplifying the transition requirements of the new leases standard by allowing a lessee to ignore not only any leases that expired prior to the effective date but also the effects of lease modifications during the comparative periods. Instead of raising comparative financial statements for prior years (here for 2018 & 2019) the company would recognize a cumulative adjustment in equity as of January 1, 2020.
Having a comprehensive understanding of the new standard and the various exemptions and practical expedients available will play a vital role when making considered business decisions when transitioning and applying ASC 842. When evaluating
, Innervision strongly recommends and encourage preparers to engage with their auditors.If you’re looking for further guidance on how to effectively transition to the new standard or if you have any other questions around how it could impact your organisation. Download our free guide, ‘The 7 Steps to Lease Accounting Compliance’.
If you are interested in finding out how lease accounting software can help streamline and accelerate your ASC 842 compliance project, why not request a free demo and consultation today.
Disclaimer: this article contains general information about the new lease accounting standards only and should NOT be viewed in any way as professional advice or service. The Publisher will not be responsible for any losses or damages of any kind incurred by the reader whether directly or indirectly arising from the use of the information found within this article.