Companies that have adopted the standard found it helpful to document their assessment of the lease term, including key judgments and corroborative information that pointed to the presence of economic compulsion, or lack thereof, leading to the company’s conclusion that it was reasonably certain (or not reasonably certain) to exercise extension options provided in the lease. However, lessons learned from early The entity would not: Restate 2017 and 2018 for the effects of applying ASC 842. For private companies, determining an incremental borrowing rate, when used as the discount rate, could be a challenging endeavor especially if an entity has few (or no) recent debt issuances. var plc282686 = window.plc282686 || 0; A land easement confers rights of a particular entity to use, access, or cross another entity’s property for a particular purpose. For example, as a result of the adoption of ASC Topic 842 on January 1, 2019, Griffin-American Healthcare REIT IV recognized an initial amount of operating lease liability of $5,334,000 in its condensed consolidated balance sheet for all of its ground leases. THE JOURNEY – GETTING STARTED. 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 || []; If an entity such as an oil or natural gas distributor using land easements to construct pipelines traversing private or public property were required to classify such arrangements as leases under the new standard, it would constitute a significant burden. https://fasb.org/jsp/FASB/Page/SectionPage&cid=1176156316498. The timing and pattern of transfer for the lease component and associated nonlease components are the same. 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. 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. ASC 842-20-45-1 requires finance and operating lease ROU assets and lease liabilities to be disclosed separately from each other and from other assets and liabilities. 1 ASU 2016-02, “Leases (Topic 842): Section C – Background Information and Basis for Conclusions,” paragraph BC14, FASB, https://fasb.org/jsp/FASB/Page/SectionPage&cid=1176156316498. 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. 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. Entities may record a cumulative adjustment to the opening balance of retained earnings in the year of adoption. Indeed, implementation of the requirement for many entities with thousands of existing and expired land easements would prove nearly impossible given their volume and age. This inherent complexity makes the transition guidance equally complex. 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' }}); For example, in a basic lease (without any incentives, etc), each period, the asset is reduced by the same amount as the liability reduction. no cumulative effect adjustment was recorded.] Under both ASC 842 and IFRS 16, the ROU asset is amortized (or depreciated for finance leases) from the lease commencement date (the date the lessee begins to make payments) to the end of the lease’s term. 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. var plc459481 = window.plc459481 || 0; Changes in the IFRS 16 and the FASB ASC 842 lease accounting requirements could have a significant financial effect on your organization. When deciding whether or not to elect the risk-free-rate practical expedient, private companies should consider the volume, significance, and diversity of their lease portfolio, as well as the resources tasked with developing management estimates. The first method allows companies to adjust financial statements to reflect ASC 842 in all periods presented on the financial statements. document.write('<'+'div id="placement_456219_'+plc456219+'">'); Entities should work closely with their independent auditors in evaluating documentation requirements, as well as in evaluating the adequacy of their existing internal control systems. The codification improvements contained in this update, combined with the practical expedients discussed in this article, have and continue to provide valuable guidance to ease the transition for entities experiencing difficulty implementing the new lease standard. 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. Determination will need to be made as to adoption of ASC 842, which is available on a modified retrospective basis or through a cumulative effect adjustment as of the beginning of the year of adjustment. Example using calendar year-end public company *Cumulative-effect adjustment to retained earnings PwC Transition if package of practical expedients is elected and hindsight is not 24 Capital Leases Carry over current balances All Leases Carry over current balances Operating Leases RoU asset & lease liability at PV of remaining “minimum rental Similar relief was not originally provided to the lessor, however, thereby requiring the entity to evaluate lease arrangements to determine any lease and nonlease components requiring separation. Heather Winiarski, CPA is a shareholder at Mayer Hoffman McCann PC, Kansas City, Mo. Though many organizations are balancing resources delicately in light of the COVID-19 pandemic, the deferral also provides organizations with extra time to develop their implementation plan and examine some lessons learned from companies that already have adopted the new standard. A Discussion of Practical Expedients in ASC Topic 842, Building a Next-Generation Internal Audit Organizational Structure, Becoming Successful in Today's Professional World, ICYMI | Seven Years at the Forefront of Standards Setting, A Look at the Auditing Standards Board’s New Audit Report, Planning for 2020 by Looking Back to 2012. var abkw = window.abkw || ''; Change how it applies the transition requirements, only when it applies the transition requirements. 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. div.id = "placement_461033_"+plc461033; Questions about lease accounting changes? In cases where operations were decentralized or many amendments were made to leases, companies that have adopted Topic 842 experienced pain points tracking lease information across different individuals involved in the organization’s leases and across multiple versions of lease agreements. This simplifies transition, as companies won’t need to record leases that expired prior to 1/1/19 or consider the effects of lease modifications during the comparative periods presented. Lessors may elect not to separate nonlease components from their related lease components. Other entities, including private companies, have more time to prepare for adoption. All rights reserved. Despite this simplification in Topic 842, identifying legally enforceable terms and conditions can be difficult in situations when a formal written agreement does not exist. Other entities, including private companies, have an additional year to prepare for adoption. 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 ASC 842, there will be no effect to the income statement, EBITDA, or debt This company would compute the retained earnings adjustment as of January 1, 2017, and adjust the comparable 2017 and 2018 income statements and the comparable 2018 balance sheet. means of a cumulative-effect adjustment to the opening retained earnings as of the beginning of the first reporting period in which the pending content that links to this paragraph is effective. Also, you must recognize the effects of applying ASC 842 as a cumulative-effect adjustment to retained earnings as of the effective/adoption date. The short version is that the look-back financials are no longer required. • 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. var div = divs[divs.length-1]; ASC Topic 842 provides lessees with an option to avoid separating nonlease components from their related lease components. Recognize the effects of applying ASC 842 as a cumulative-effect adjustment to retained earnings as of January 1, 2019. ICYMI | Failure Study: A Needed Addition to the Accounting Toolkit, Building a Next-Generation Internal Audit…, Becoming Successful in Today’s Professional…, More Bankruptcies, More Opportunities and…, Becoming Successful in Today’s Professional World. While many entities are balancing more responsibilities than ever because of the disruption caused by COVID-19, the sooner an entity’s implementation process for Topic 842 begins, the easier it will be. 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. 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. Topic 842 characterizes operating lease liabilities as operating liabilities instead of debt and therefore typically should not affect most debt covenant calculations. • Date of initial application — The first day an entity applies the transition provisions of ASC 842 to its var divs = document.querySelectorAll(".plc461032:not([id])"); 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. Operating leases (ASC 842) The amortization of the ROU asset for operating leases is not recognized as depreciation expense. Entities are also provided relief from having to reevaluate existing lease classifications. Under the new standard, companies are required to capitalize operating leases on the balance sheet — reporting them as right-of-use assets and lease liabilities . 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. (function(){ Cumulative adjustment in period of adoption. The development of ASC Topic 842 is the product of several years of deliberations by FASB in concert with the IASB, informed by input from user groups. Finally, entities eligible for the election are not required to elect the package of practical expedients provided in ASC Topic 842 in order to avail themselves of this practical expedient. 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. guidance, codified in ASC 842, Leases, will be calculating, recording, and disclosing the adjustments necessary to transition from the legacy lease accounting guidance codified in ASC 840. 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. Under Topic 842, related-party leases should be accounted for based on their legally enforceable terms and conditions. Consistent with its simplification project, FASB issued ASU 2018-11, “Leases (Topic 842)—Targeted Improvements,” to further reduce the burden of implementing the new lease standard. Leases (Topic 842) No. ROU asset amortization period. Cumulative adjustment in period of adoption. ASC Topic 842 defines initial direct costs as those that could have been avoided had the entity not entered into a lease agreement. Also, discuss with stakeholders the planned implementation approach, including whether a preference exists for comparability of prior periods reported in the financial statements. Per correspondence with the Region 1 office of the NCUA, the answer to the first question is there is no additional reporting necessary on the Call Report to show the cumulative-effect adjustment. Many public companies found that determining incremental borrowing rates for their leases required accumulating more data and making more judgments than initially thought. GAAP (ASC 840) to the new lease accounting standard (ASC 842). Prior periods presented would continue under guidance in ASC 840. (function(){ document.write('<'+'div id="placement_289809_'+plc289809+'">'); Introduction to the ASC 842 accounting standard In 2019, the latest FASB lease accounting standard, ASC 842, began to go into effect for public company filers. In addition, entities may elect a practical expedient to use hindsight in determining the lease term and in assessing the impairment of the entity’s right-of-use assets. 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. Companies that have yet to adopt Topic 842 are sure to encounter some challenges executing their implementation. recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption without adjusting the comparative periods presented. GAAP (ASC 840) to the new lease accounting standard (ASC 842). The answer to the second question isn’t as obvious. Early adoption is permitted, so some organizations may choose to go ahead and make the transition as originally scheduled anyway. Edited by CPAs for CPAs, it aims to provide accounting and other financial professionals with the information and analysis they need to succeed in today’s business environment. Although the effective date for implementing the standard has passed for publicly held entities, private entities still have time to make changes. • 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 Are CPAs Prepared to Discuss the U.S. Government's Financial Position? var AdButler = AdButler || {}; AdButler.ads = AdButler.ads || []; Companies with a significant number of leases might face challenges identifying a complete population of leases and all current lease data. A further expedient provided in ASC Topic 842 applies only to private entities. The impact on lessees. var plc289809 = window.plc289809 || 0; Transition – BREAKING NEWS! Such rights may be permanent or limited and may be exclusive or shared with other entities. In effect, the lessee is permitted to treat the lease and its related nonlease components as one component, thereby reducing the burden of having to account for lease components under the new guidance and nonlease components under other guidance. Banks with whom the FASB conducted outreach indicated they are unlikely to “call a loan” with a good customer because of a technical default arising solely because of the adoption of new GAAP. For example, determining adjustments to prevailing market interest rates for entity-specific credit risk and the impact of full collateralization proved to be a pain point for public companies. Topic 842 allows lessees to choose to either 1) separate lease and nonlease components and allocate consideration based on stand-alone selling price or 2) combine lease and nonlease components and account for them as a single lease component. 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. Guide to auditing the implementation of ASC 842, Leases | 1 . Although ASU 2018-10, “Codification Improvements to Topic 842, Leases,” does not specifically address any additional practical expedients, it does provide several amendments that clarify existing guidance with respect to ASC Topic 842 and subsequent updates; this is consistent with FASB’s ongoing simplification. Compliance with the … The new lease accounting standards are significantly changing the accounting for operating leases.In this blog, we will provide a comprehensive example of operating lease accounting under ASC 842. 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. A reclassification of an operating lease under ASC Topic 840 to an operating lease under ASC Topic 842 would have no effect on the income statement. The lease component, if accounted for separately, would be classified as an operating lease. var plc459496 = window.plc459496 || 0; Using the lessons learned by public companies that have adopted the standard and developing an understanding of the key differences between Topic 842 and Topic 840 are just a couple of steps that private companies can take in the near term. 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. (function(){ Almost all entities with operating leases will experience some impact from the eventual adoption of the new lease accounting standard. Many companies that have adopted Topic 842 found that the adoption process took much longer than expected, for a variety of reasons. ASC Topic 842 provides lessees with an option to avoid separating nonlease components from their related lease components. div.id = "placement_459496_"+plc459496; If you were worried about comparative reporting, the new transition option is a relief. This election will help entities save the effort and time of maintaining lease schedules for leases of short duration. Provide the disclosures required by ASC 842 for 2017 and 2018. 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. Of course, if so elected, the lessor would have to apply the same guidance to an entire class of underlying assets. When determining whether or not to use any of these expedients, remember that some are industry-specific, so it's essential to understand how the new lease standards relate to your business entity. 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. The entity can simply carry forward its previous conclusions reached under ASC 840 when adopting ASC 842. It is essential that companies understand the capabilities of their existing information systems, accounting, and administrative controls. This is expected to save entities time during transition by not requiring them to determine the information available at the inception of the leases. })(); The CPA Journal is a publication of the New York State Society of CPAs, and is internationally recognized as an outstanding, technical-refereed publication for accounting practitioners, educators, and other financial professionals all over the globe. AdButler.ads.push({handler: function(opt){ AdButler.register(165519, 461032, [300,250], 'placement_461032_'+opt.place, opt); }, opt: { place: plc461032++, keywords: abkw, domain: 'servedbyadbutler.com', click:'CLICK_MACRO_PLACEHOLDER' }}); Should evaluate the nature and extent of related-party leases, particularly those intended to simplify transition and used... No longer required incremental borrowing rates for their leases required accumulating more data and more. So some organizations may choose to go public might influence a decision to use a practical expedient for. 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