FASB Issues Improvements to the New Lease Accounting Standard

Charles Soranno, Managing Director Internal Audit and Financial Advisory

On July 30, 2018, the Financial Accounting Standards Board (FASB) issued ASU No. 2018-11, a long-awaited – but expected – update to pending changes in lease accounting standards, intended to reduce implementation costs and burden. The update provides a new, simplified transition method (relief that has been on the FASB agenda since the end of 2017) and a practical expedient to separating contract components as required by the new standard, which is scheduled to become effective for public companies in fiscal years beginning after December 15, 2018 (effectively January 1, 2019 for calendar-year public filers), and for private companies a year later.

Protiviti has published a Flash Report that examines the provisions of ASU No. 2018-11 and puts the changes in context. Here are some highlights:

  • An entity applying the new lease accounting standard may record a cumulative adjustment to the opening balance of retained earnings in the period of adoption, instead of having to restate comparative results, as initially required. An entity that elects this transition method must provide the required Topic 840 (the current FASB standard for lease accounting) disclosures for all periods that continue to be in accordance with Topic 840.
  • As a practical expedient, lessors may elect to not separate non-lease components from lease components if the non-lease component otherwise would be accounted for under the new revenue guidance (Topic 606), and both of the following conditions are met:
    • The timing and pattern of transfer of the non-lease component(s) and associated lease component are the same.
    • The lease component, if accounted for separately, would be classified as an operating lease.

The amendments in the update affect changes required by the previously issued ASU 2016-02, which is not yet effective but can be adopted early. All entities, including early adopters that elect the practical expedient related to separating components of a contract, must apply the expedient, by class of underlying asset, to all existing lease transactions that qualify for the expedient on the date elected.

As detailed in a previous Flash Report issued on March 1, 2016, the FASB’s new accounting standard (ASU No. 2016-02), which this new adjustment applies, revolutionizes lease accounting by requiring lessees to recognize a lease liability and a right-of-use asset for all leases (except for short-term leases, i.e., those with duration of less than one year) on their balance sheets as of the date on which the lessor make the underlying asset available to the lessee.

The new lease accounting ASU is a win for companies preparing for the lease accounting standard. Yet it is clear that many public companies are still struggling to meet the deadlines. Common transition issues continue to be: assessing the validity, completeness and accuracy of the company’s existing lease portfolio; challenges in prior lease classification; and identifying and quantifying the pool of embedded leases (such as equipment service agreements that need to be separated, quantified and reported separately).

Additionally, the proper identification and availability of information technology systems and the time necessary to execute the new standard through new applications, as well as the technical resources needed to implement them, have been challenges throughout the lease accounting standard transition process.

That said, as long as companies follow a complete, thoughtful documented lease transition road map, pursue the work diligently, have the affected financial statement changes auditable, and have their business process and IT change management protocols in place, they should be able to execute a compliant transition to the new lease accounting standard.

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