accounting standards

Article Dean Dorton

Are you ready for the new lease accounting standard – known as FASB Accounting Standards Codification (ASC) 842, Leases?

What is changing?

The new lease standard requires a lessee to record all leases on the balance sheet, unless the lease term is 12 months or less. This represents a significant change from historical lease accounting rules, which only required assets and liabilities to be recorded for capital leases, but not for operating leases. Overall, the new standard should not change a company’s income statement or cash flow statement, but it may have material impacts to the balance sheet.

The intent of the new standard is to reduce the amount of off-balance sheet activity, providing financial statement users with greater transparency regarding the leasing activity and associated rights and obligations of lessees. Unintended consequences may include significantly impacting financial ratios and compliance with loan covenants.

When are the lease accounting changes effective?

The new standard will be effective for non-public business entities beginning with calendar year 2022. Many implementation lessons can be learned from public entities, as they implemented the leasing standard prior to private companies being required to implement the standard. To ease adoption, companies can elect a transition method whereby a cumulative-effect adjustment is recorded to opening retained earnings in the period of adoption, thus precluding restatement of prior periods.

Gathering the lease portfolio can be extremely difficult

Identification of a complete lease population is the first, and often most challenging, step in implementation, due to:

  • Decentralization of agreements and data for leases historically classified as operating leases
  • The requirement to search for embedded leases in service agreements and other contracts

An embedded lease could be present if a contract contains an explicitly or implicitly identified asset, and the company controls the use of this asset. For example, transportation and delivery service agreements could contain an embedded lease if a specific vehicle must be used to transport your company’s inventory. Cloud computing service agreements could contain embedded leases if specific IT servers are dedicated to your company.

Additional implementation challenges

Other common issues include:

  • Extent of effort required to adopt – Implementation frequently requires 6 – 12 months of cross-functional involvement, which can be a significant burden coming on the heels of the new revenue recognition standard.
  • Developing an IT solution to manage compliance – Spreadsheet-based lease management tools often are no longer sufficient, given the increase in the volume of leases on the balance sheet and the complexity of measuring such assets and liabilities. Lease accounting software may be required to successfully manage all lease data.

Preparation for the new lease accounting standard should start now.  Dean Dorton welcomes any questions about how the new standard will impact your business. Learn more about us, and our services at the link below:

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Article Dean Dorton

When do you recognize revenue from contracts with customers? What was once an easy question to answer is now one that will soon require a multi-step analysis. For private entities, Accounting Standards Update (ASU) 2014-09 will be required for annual reporting periods beginning after December 15, 2018. Although we are one full year from implementation, there is various information that needs to be gathered and organized in order to implement ASU 2014-09 correctly.

The core principle behind ASU 2014-09 is that “an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” Simply stated, entities must recognize revenue as performance obligations are satisfied. In order to identify such performance obligations, the following process should be followed:

First, contracts with customers must be identified. Applicable contracts under the new standards are those that have approval of both parties, have commercial substance, and have probable collectability of substantially all the consideration to which the entity is entitled. In addition, the contract must have approval of both parties, along with corresponding payment terms. Once applicable contracts are determined, performance obligations need to be identified therein.

A performance obligation is a promise within a contract to transfer a good or service to a customer. This good or service should be distinct, meaning it is readily identifiable from other goods or services outlined in the contract. Contracts may have one or more performance obligations. The corresponding transaction price of the contract must then be determined.

The transaction price is the amount of consideration the entity expects to receive in return for the transfer of goods or services to the customer. This transaction price should take into consideration payables to the customer, existing financing components, non-cash, and variable considerations. Keep in mind the terms of the contract, as well as your standard business practices in determining the transaction cost. Once the transaction cost is determined, it can then be allocated to the performance obligations previously identified.

Each performance obligation is allocated a portion of the transaction price based on the standalone selling price of the goods or services being transferred. If a standalone selling price is not easily identifiable, then one should be estimated. One item to note is that reallocation of the transaction price based upon a change in standalone selling price is not permitted under this new standard. Now that each performance obligation is assigned a transaction price, revenue can be recognized accordingly as the obligation is satisfied.

As the implementation date for ASU 2014-09 draws near, it is imperative that data and information for all contracts with customers be gathered and analyzed based upon this five-step process. For further guidance, please reach out to your external CPA and AICPA’s Financial Reporting Center (FRC). The FRC includes a list of conferences, webcasts, and other publications to keep you updated on the most recent developments regarding the standard’s implementation.

Article Dean Dorton

On February 25, 2016, the Financial Accounting Standards Board (FASB) issued its new lease accounting guidance in Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842).

The ASU will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases, unless the lease is a short term lease.

Short term leases
A short term lease is defined in the ASU as “a lease that, at the commencement date, has a lease term of 12 months or less and does not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise”.  The lease term is defined as the noncancellable period for which a lessee has the right to use an underlying asset, together with all of the following:

  • Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option.
  • Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option.
  • Periods covered by an option to extend (or not to terminate) the lease in which exercise of the option is controlled by the lessor.

For short term leases, a lessee is permitted to make an accounting policy election by class of underlying asset 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.

Leases not considered short term
For all other leases, the lessee will be required to recognize the following at the commencement date of the lease:

  • A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and
  • A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

When measuring assets and liabilities arising from a lease, a lessee (and a lessor) should include payments to be made in optional periods only if the lessee is reasonably certain to exercise an option to extend the lease.  Similarly, optional payments to purchase the underlying asset should be included in the measurement of lease assets and lease liabilities only if the lessee is reasonably certain to exercise that purchase option. Reasonably certain is a high threshold. In addition, a lessee (and a lessor) should exclude most variable lease payments in measuring lease assets and lease liabilities, other than those that depend on an index or a rate or are in substance fixed payments.

Consistent with current Generally Accepted Accounting Principles (GAAP), the recognition, measurement, and presentation in the statements of income and cash flows will depend on the lease’s classification as a finance or operating lease.

  • For finance leases, a lessee is required to:
    • Recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of income.
    • Classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows
  • For operating leases, a lessee is required to:
    • Recognize a single lease cost in the statement of income (which will include both the amortization of the right-of-use asset and the “interest” element associated with the lease liability), calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis.
    • Classify all cash payments within operating activities in the statement of cash flows.

The ASU also will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements.

Lessor accounting
Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers.

Sale and leaseback transactions
The new lease guidance also simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing.

Effective dates
Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Nonpublic business entities should apply the amendments for fiscal years beginning after December 15, 2019 (i.e., year ending December 31, 2020 for a calendar year entity), and interim periods within fiscal years beginning after December 15, 2020. Early application is permitted for all public business entities and all nonpublic business entities upon issuance.

Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach.

If you have any questions regarding this new standard or would like assistance in implementing the new standard, please contact your Dean Dorton advisor, or:

David Richard, Director of Assurance Services: drichard@deandorton.com
Simon Keemer, Director of Assurance Services: skeemer@deandorton.com


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Article Dean Dorton

The Financial Accounting Standards Board (FASB) has developed guidance that it believes will improve the information provided in financial statements and disclosures for non-for-profit entities. The proposed guidance is Accounting Standards Update 2015-230 Presentation of Financial Statements of Not-for-Profit Entities and Health Care Entities. The proposed changes could have a major impact on the following reporting areas:

  • Net Asset Classification
    • The net asset classifications (permanently restricted, temporarily restricted, and unrestricted) would be replaced with only two net assets classes (net assets with donor restrictions and net assets without donor restrictions).
  • Statement of Activities
    • Expenses would be required to be reported by both their nature and function either on the face of the statement of activities or disclosed in the footnotes. Investment expenses would be netted with investment income to allow users to identify the net profit from the entity’s portfolio.
  • Cash Flows
    • The direct method of reporting cash flows for operating activities would be required in addition to changing the classification of certain cash flows.
  • Liquidity
    • Required disclosures of quantitative and qualitative information on liquidity of assets including the amount of financial assets at the end of each period, limited or restricted for use assets, and how the organization manages its liquidity.

The changes in these areas will provide donors and the public with more information about the organizations and how they spend and invest donor money. However, there are concerns are that the cost and results of implementation will outweigh the benefits of the changes. Some criticisms the proposal has received are that the changes will create too much of a divide between not-for-profit and for-profit accounting and therefore, will make it difficult for the end users of financial statements, and will create more reconciliation differences between IRS Form 990 and the financial statements.

Comments were due to FASB by August 20, 2015. FASB will hold a roundtable on September 21, 2015 to further discuss these changes.

For further information, read the Exposure Draft or FASB In Focus.