Questions about lease accounting changes? 17. It is essential that companies understand the capabilities of their existing information systems, accounting, and administrative controls. Cumulative adjustment in period of adoption. AdButler.ads.push({handler: function(opt){ AdButler.register(165519, 459481, [300,250], 'placement_459481_'+opt.place, opt); }, opt: { place: plc459481++, keywords: abkw, domain: 'servedbyadbutler.com', click:'CLICK_MACRO_PLACEHOLDER' }}); if (!window.AdButler){(function(){var s = document.createElement("script"); s.async = true; s.type = "text/javascript";s.src = 'https://servedbyadbutler.com/app.js';var n = document.getElementsByTagName("script")[0]; n.parentNode.insertBefore(s, n);}());}. Many companies that have adopted Topic 842 found that the adoption process took much longer than expected, for a variety of reasons. Such election, however, is not available to entities that followed the guidance provided in ASC Topic 840; thus, entities previously following that guidance must apply the provisions of ASC Topic 842 to land easements existing or expiring prior to its passage. Under Topic 842, companies are required to evaluate whether an agreement “conveys the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration,” regardless of how the contract is characterized. Explore Crowe insights and learn more about how we can help. Cumulative adjustment in period of adoption. Other entities, including private companies, have ... to “recognize a cumulative-effect adjustment to the opening balance of retained earnings” at their document.write('<'+'div id="placement_289809_'+plc289809+'">'); statements by recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the adoption year. Here are some key lessons learned from public companies, as well as other considerations that private companies should evaluate as part of their implementation plan for the significant changes to lease accounting. The new treatment should improve financial reporting by making it easier for companies to change to a method that better reflects how … (function(){ All other entities (e.g., privately held) will have to comply with the new guidance for annual periods beginning after December 15, 2020 (including all interim periods within fiscal years beginning after December 15, 2021). If most of the consideration received by the lessor is related to the nonlease component, the lessor would follow ASC Topic 606 or other applicable guidance. Many credit agreements contain “frozen GAAP” provisions that indicate that changes in GAAP will not constitute a default or will require both parties to negotiate in good faith if technical default occurs as a result of the adoption of new GAAP. var div = divs[divs.length-1]; Thus, if most of the consideration is related to the lease component, the lessor would follow the guidance in ASC Topic 842. Legal staff must work with accounting and internal auditing staff in order to evaluate the nature of contractual obligations and determine the extent of leases embedded in contracts. The impact on lessees. It is important for lessee management in particular to understand and evaluate the impact of the new standard on existing debt covenants and other agreements that utilize financial ratios. Not every agreement that will qualify as a lease under Topic 842 will have the word “lease” in it. var plc456219 = window.plc456219 || 0; An example of when a cumulative effect retained earnings adjustment might be required is if a sale-leaseback gain was deferred under Topic 840 but qualifies for recognition under Topic 842. Indeed, successful application of the new standard will require an ongoing, collaborative effort that will prove difficult and costly for many entities in the early years. Again, the entity can elect to avoid reassessing these costs during the transition period; however, the entity cannot elect only one or two of the practical expedients, but must elect all three of them as a single package. Therefore, many companies will not have a cumulative effect adjustment to make upon adoption of Topic 842, as the situations that call for such an adjustment are limited. This practical expedient simplifies ASC 842 transition requirements, eliminating the need to record leases that expired prior to the effective date or consider the effects of lease modifications during the comparative periods. })(); var AdButler = AdButler || {}; AdButler.ads = AdButler.ads || []; Entities are also provided relief from having to reevaluate existing lease classifications. A further expedient provided in ASC Topic 842 applies only to private entities. The alternative is to “recognize a cumulative-effect adjustment to the opening balance of retained earnings” at their adoption date rather than on Jan. 1, 2017. Companies that have adopted Topic 842 noted that the amount of data and calculations required to prepare journal entries and disclosures under Topic 842 is far more burdensome than under Topic 840. This practical expedient simplifies ASC 842 transition requirements, eliminating the need to record leases that expired prior to the effective date or consider the effects of lease modifications during the comparative periods. Are CPAs Prepared to Discuss the U.S. Government's Financial Position? Lessors may elect not to separate nonlease components from their related lease components. For example, in a basic lease (without any incentives, etc), each period, the asset is reduced by the same amount as the liability reduction. AdButler.ads.push({handler: function(opt){ AdButler.register(165519, 456219, [300,600], 'placement_456219_'+opt.place, opt); }, opt: { place: plc456219++, keywords: abkw, domain: 'servedbyadbutler.com', click:'CLICK_MACRO_PLACEHOLDER' }}); var AdButler = AdButler || {}; AdButler.ads = AdButler.ads || []; Operating leases (ASC 842) The amortization of the ROU asset for operating leases is not recognized as depreciation expense. As part of its response to the COVID-19 pandemic, the FASB postponed the effective date of its new lease accounting standard – Accounting Standards Update (ASU) 2016-02, “Leases (Topic 842),” for privately held entities by one more year. If not elected, the lessee must apply other guidance with respect to its accounting treatment of nonlease components (e.g., application of ASC Topic 350, “Intangibles—Goodwill and Others”). This guide was fully updated in … n 2019, the new FASB lease accounting standard, ASC 842, began to go into effect for public company filers. first apply ASC 842 and recognize an adjustment for the effects of the transition as of January 1, 2017 (i.e., the date of initial application). In some cases, it may be from the commencement date to the end of the useful life of the asset. This is a change in practice from the legacy guidance within Topic 840, which required entities to look beyond the terms of the arrangement and account for the lease based on the economic substance of the arrangement. In addition to the rental of stores, offices, warehouses, and other real property, the new standard also will affect a broad range of equipment leases – from vehicles and heavy machinery to specialized scientific and laboratory equipment and even everyday copiers and printers. var divs = document.querySelectorAll(".plc461032:not([id])"); Some companies have found a manual system sufficient; however, a company that has a significant volume of leases or has to account for modifications or impairments could find a manual system unwieldy over time. However, lessons learned from early PwC’s Leases guide is a comprehensive resource for lessees and lessors to account for leases under the new leases standard (ASC 842). AdButler.ads.push({handler: function(opt){ AdButler.register(165519, 459496, [300,600], 'placement_459496_'+opt.place, opt); }, opt: { place: plc459496++, keywords: abkw, domain: 'servedbyadbutler.com', click:'CLICK_MACRO_PLACEHOLDER' }}); div.id = "placement_459496_"+plc459496; Companies should evaluate the accounting implications of this election. Maryann Townsend, EdD is an associate professor of management and MIS, also at Lindenwood University. Another practical expedient provided in the guidance is an election to avoid having to apply a provision of ASC Topic 842 that requires a lessee to break down consideration paid in connection with a contract into lease and nonlease components. The CPA Journal 14 Wall St. 19th Floor New York, NY 10005 [email protected]. To address this complexity, the Financial Accounting Standards Board (FASB) has provided several practical expedients entities may use for the transition.Effective dates 1. Such rights may be permanent or limited and may be exclusive or shared with other entities. Under Topic 842, a lessee’s identification of embedded leases has a heightened importance compared to legacy GAAP because these leases will now require recognition on the company’s balance sheet. The short version is that the look-back financials are no longer required. As we have seen so far, the adoption of ASC 842 makes accounting much more complex for traditional operating leases. Under ASC 842, there will be no effect to the income statement, EBITDA, or debt Provide the disclosures required by ASC 842 for 2017 and 2018. The short version is that the look-back financials are no longer required. This practical expedient relieves the entity from having to apply the provisions of ASC Topic 842 at the beginning of the earliest period presented in the year of adoption, which would require it to restate the prior years in comparative financial statements. It is worth emphasizing, however, that several mitigating factors exist with respect to effects of adopting Topic 842 on an entity’s balance sheet, including these1: The time required to prepare for Topic 842, specifically for organizations with significant leasing activities, should not be underestimated. ASU 2018-11 amends ASC 842 so that entities may elect not to recast their comparative periods in transition (the “Comparatives Under 840 Option”). var abkw = window.abkw || ''; • Many examples provided to guide both lessors and lessees: See 842-10-55-243 through 254 • Section 842-10-65-1 has several pages covering “practical expedients” with illustrations. var divs = document.querySelectorAll(".plc459496:not([id])"); Glossary of key terms • Commencement date of the lease (commencement date) — The date on which a lessor makes an underlying asset available for use by a lessee. For example, this election allows publicly held entities with a calendar year-end to begin applying ASC Topic 842 on January 1, 2019, and privately held entities on January 1, 2021. Guide to auditing the implementation of ASC 842, Leases | 1 . Other entities, including private companies, have an additional year to prepare for adoption. Update 2018-01—Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842: January 2018: The amendments in this Update affect the amendments in Update 2016-02, which are not yet effective but may be early adopted, and Example 10 of Subtopic 350-30. Evaluate the nature and extent of related-party leases, particularly those with terms and conditions that are not formally documented. })(); if (!window.AdButler){(function(){var s = document.createElement("script"); s.async = true; s.type = "text/javascript";s.src = 'https://servedbyadbutler.com/app.js';var n = document.getElementsByTagName("script")[0]; n.parentNode.insertBefore(s, n);}());} var AdButler = AdButler || {}; AdButler.ads = AdButler.ads || []; ASC 842 closes the lease accounting off-balance sheet loophole which allowed corporations to report their operating leases, often a major portion of the lease portfolio, in the footnotes of financial statements . var abkw = window.abkw || ''; Instead, companies would recognize a cumulative-effect adjustment in equity upon adoption as of January 1, 2019. Under this approach, the standard is implemented either (1) as of the earliest period presented and through the comparative periods in the entity’s financial statements or (2) as of the effective date of ASC 842 (the “Comparatives Under 840 Option”), with a cumulative-effect adjustment to equity in the first period in which ASC 842 is adopted. If you were worried about comparative reporting, the new transition option is a relief. The first method allows companies to adjust financial statements to reflect ASC 842 in all periods presented on the financial statements. In addition, many contracts contain lease and nonlease components, meaning that a contract may have characteristics that qualify as a lease and other characteristics that don’t. [If ASC 606 had an impact…whether in presentation only (e.g., gross vs. net) or recognition-related:] The income statement impact of adopting ASC 606 for the period ending XXX is outlined below: [Tailor this chart to include only those line items impacted by ASC 606.] div.id = "placement_461032_"+plc461032; ASU 2018-10 grants this relief to lessors provided that both of the following conditions are met: Furthermore, the guidance requires the lessor to follow the guidance related to the predominant component of the combined component. Almost all entities with operating leases will experience some impact from the eventual adoption of the new lease accounting standard. The purpose of this article is to summarize and discuss the expedients provided in the standard and its recent amendments. As mentioned previously, this election significantly reduced the burden in transitioning to the new standard by allowing entities to avoid having to restate prior-year comparative financial statements and to make related disclosures. recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption without adjusting the comparative periods presented. Recognize the effects of applying ASC 842 as a cumulative-effect adjustment to retained earnings as of January 1, 2019. Lease accounting under ASC 842: practice issues and implementation We will be starting soon Tuesday, May 15, 2018 1:00 - 2:30 pm ET Please disable pop-up blocking software before The impact on lessees. The entity would not: Restate 2017 and 2018 for the effects of applying ASC 842. • Recognize the effects of applying ASC 842 as a cumulative-effect adjustment to retained earnings as of the effective date; The entity would not: • Restate comparative periods • Provide the disclosures required by ASC 842 for the comparative periods. Without this update, the lessor would have to apply the guidance provided in ASC Topic 842 with respect to any lease components while following the revenue recognition rules in ASC Topic 606, “Revenue from Contracts with Customers,” with respect to any nonlease components (or other applicable guidance). Also, discuss with stakeholders the planned implementation approach, including whether a preference exists for comparability of prior periods reported in the financial statements. This example uses a single lease example, rather than a portfolio of leases, to illustrate the accounting under current guidance, the transition entry to ASC 842, and go forward accounting for leases that existed at the effective date. Alternatively, organizations can choose instead to bring existing leases into compliance with Topic 842 as of the beginning of the year of adoption (effective date method), without adjusting comparative periods that are presented in the financial statements. The practical expedients in ASU 2018-11 provide for the following: This practical expedient relieves the entity from having to apply the provisions of ASC Topic 842 at the beginning of the earliest period presented in the year of adoption, which would require it to restate the prior years in comparative financial statements. During the transition period, entities are also provided relief from having to reevaluate and exclude certain outlays classified as initial direct costs under ASC Topic 840. 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