New Lease Standard

Written on March 10, 2016

On February 25, 2016, the FASB issued Accounting Standards Update (ASU) 2016-02, Leases. The new standard creates Topic 842, Leases, in the FASB Accounting Standards Codification (FASB ASC) and supersedes FASB ASC 840, Leases. Entities that hold equipment and real estate leases, in particular those with operating leases, will be most affected by the new guidance. The amendments in ASU 2016-02 are expected to impact balance sheets at many companies by adding lease-related assets and liabilities. This may affect compliance with contractual agreements and loan covenants. The main difference between the existing guidance and the new standard is that operating leases will now be recorded in the statement of financial position as assets and liabilities. Current U.S. GAAP requires only capital (finance) leases to be recognized in the statement of financial position and amounts related to operating leases largely are reflected as rent expense on the income statement and in disclosures to the financial statements. ASU 2016-02 retains a distinction between finance leases and operating leases. The criteria for distinguishing between finance leases and operating leases are substantially similar to the criteria for distinguishing between capital leases and operating leases in existing U.S. GAAP. However, the lease criteria in ASU 2016-02 does not depend on bright-line thresholds as they do in existing U.S. GAAP. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term. Effective Date and Transition The amendments in ASU 2016-02 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, 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 added, 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 • For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early application of the amendments is permitted for all entities. We will cover ASU 2016-02 in greater detail in future alerts.

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