Leasing isn't an exciting topic. So then why is everyone suddenly interested in leasing?
Because of ASC 842, and its IFRS cousin, IFRS 16, that’s why! While these new standards are slightly different (IFRS requires all lessee leases to be treated as “direct finance” or capital leases, while ASC 842 classifies some leases as direct finance and others as operating leases), both are going to drastically change financial statement preparation and presentation, and hence will affect your everyday accounting. While the change affects both lessors and lessee, the biggest impact is going to be on the lessee side of things.
Think of any business…now ask if it has leases? Cars, office equipment, facilities, property. Most businesses lease these assets, and under today’s standards, if these can be classified as “operating leases” they have no direct impact on the balance sheet; as lease payments are made, they are expensed. Of course, your disclosures and notes will have the relevant details, but a quick look at the balance sheet might give a much different picture than reality. Hence, both FASB and IASB are moving to adopt a new standard, which makes lessee balance sheet presentation of virtually all leases mandatory, including operating leases over 12 months. Key balance sheet measures and ratios will change, affecting the perception of your company by financial statement readers and users, as well as changing the outlook from an analyst’s perspective.
Using a 4 step criteria, outlined in 842-10-25-2 to 3, each lease will be classified as either a “finance” (aka capital) or an operating lease. At that point, a “right to use” asset will be placed on the balance sheet, offset by a lease liability at the present value of the unpaid lease payments.For
For lessors, leases will be broken down into operating, sales-type or direct finance leases. The new accounting standard retains most of the basic lessor accounting found in today’s standards. However, there is a significant change in the definition of initial direct costs which can be included in the lease. Some costs the current standards allow to be capitalized, such as legal fees and other allocated internal costs and overhead, will have to be expensed, resulting in higher upfront expense costs and higher margins over the term of the lease. In addition, lease and non-lease components need to be treated under ASC 606, requiring the definition of standalone selling prices and the reallocation of revenue for the non-lease components.
Know what the scary part of this is? The new standard takes effect in 2019 for public companies and 2020 for private, with 2 years of retrospective presentation. So, if you are just learning of ASC 842 today, you need to contact your CPA and determine how it will impact your business, because the change is just around the corner.
Binary Stream’s Property Management simplifies both lessor and lessee lease accounting across multiple industries and sectors. We are hard at work on a version that is ASC 842 compliant. For more information, please contact your VAR or visit us at www.binarystream.com/asc842.