Many public companies found that determining incremental borrowing rates for their leases required accumulating more data and making more judgments than initially thought. Other entities, including private companies, have an additional year to prepare for adoption. Furthermore, this update provides clarity in its implementation guidance (e.g., Example 10, 350-30-55-30) that land easements first should be assessed under ASC Topic 842 to determine whether they meet the definition of a lease and that permanent easements do not meet the definition of a lease under ASC Topic 842. Not every agreement that will qualify as a lease under Topic 842 will have the word “lease” in it. Questions about lease accounting changes? 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. In this respect, this update has significantly reduced the complexity and cost of implementing the new lease standard for publicly held companies who must now follow the new guidance, and will similarly reduce the burden on privately held entities who will shortly have to comply with ASC Topic 842. Some companies might find it necessary to revisit processes and controls over maintaining information regarding lease contracts and disseminating that information across the organization. In the case of the implementation of Topic 842, however, cumulative net income commonly is the same under Topic 840 and Topic 842 as of the date of initial application. During the transition period, entities are also provided relief from having to reevaluate and exclude certain outlays classified as initial direct costs under ASC Topic 840. © 2019 The New York State Society of CPAs. 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 ASC Topic 842 provides lessees with an option to avoid separating nonlease components from their related lease components. However, lessons learned from early The first method allows companies to adjust financial statements to reflect ASC 842 in all periods presented on the financial statements. var abkw = window.abkw || ''; var plc461033 = window.plc461033 || 0; 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. In addition to the rental of stores, offices, warehouses, and other real property, the new standard also will affect a broad range of equipment leases – from vehicles and heavy machinery to specialized scientific and laboratory equipment and even everyday copiers and printers. 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. 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. Maryann Townsend, EdD is an associate professor of management and MIS, also at Lindenwood University. An example derived from ASC 842 illustrates the transition for an operating lease:5 The effective date for the entity to adopt ASC 842 is Jan. 1, 2019. AdButler.ads.push({handler: function(opt){ AdButler.register(165519, 461033, [300,600], 'placement_461033_'+opt.place, opt); }, opt: { place: plc461033++, keywords: abkw, domain: 'servedbyadbutler.com', click:'CLICK_MACRO_PLACEHOLDER' }}); The short version is that the look-back financials are no longer required. 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. This practical expedient simplifies ASC 842 transition requirements, eliminating the need to record leases that expired prior to the effective date or consider the effects of lease modifications during the comparative periods. var divs = document.querySelectorAll(".plc461033:not([id])"); var abkw = window.abkw || ''; Leases (Topic 842) No. 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. All rights reserved. Explore Crowe insights and learn more about how we can help. The entity can simply carry forward its previous conclusions reached under ASC 840 when adopting ASC 842. var abkw = window.abkw || ''; document.write('<'+'div id="placement_282686_'+plc282686+'">'); var plc459496 = window.plc459496 || 0; Under this approach, the standard is implemented either (1) as of the earliest period presented and through the comparative periods in the entity’s financial statements or (2) as of the effective date of ASC 842 (the “Comparatives Under 840 Option”), with a cumulative-effect adjustment to equity in the first period in which ASC 842 is adopted. It is essential that companies understand the capabilities of their existing information systems, accounting, and administrative controls. Whatever system approach is chosen, companies also should begin designing and implementing controls over the reconciliation of leases and posting of periodic journal entries. • Date of initial application — The first day an entity applies the transition provisions of ASC 842 to its This guide was fully updated in … AdButler.ads.push({handler: function(opt){ AdButler.register(165519, 282686, [300,250], 'placement_282686_'+opt.place, opt); }, opt: { place: plc282686++, keywords: abkw, domain: 'servedbyadbutler.com', click:'CLICK_MACRO_PLACEHOLDER' }}); 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 || []; Most entities, such as a trucking company or airline with many leases existing at that date, would elect to avail themselves of this expedient given the significant cost of having to review all contracts to determine whether they do or do not contain a lease or a lease component. For instance, take a calendar-year filer required to show three years of income statements and two balance sheets, and adopting ASC 842 on January 1, 2019. The practical expedients in ASU 2018-11 provide for the following: This practical expedient relieves the entity from having to apply the provisions of ASC Topic 842 at the beginning of the earliest period presented in the year of adoption, which would require it to restate the prior years in comparative financial statements. This election will help entities save the effort and time of maintaining lease schedules for leases of short duration. Private companies can elect to use a practical expedient under Topic 842, which allows the use of a risk-free interest rate, scaled to the length of the lease, in lieu of a calculated discount rate. Design and implement controls now to verify that the initial implementation includes a complete listing of leases and agreements with potential embedded leases. ROU asset amortization period. document.write('<'+'div id="placement_456219_'+plc456219+'">'); Instead, in this example, the company would recognize a cumulative adjustment in equity as of January 1, 2020. • Many examples provided to guide both lessors and lessees: See 842-10-55-243 through 254 • Section 842-10-65-1 has several pages covering “practical expedients” with illustrations. 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. This practical expedient simplifies ASC 842 transition requirements, eliminating the need to record leases that expired prior to the effective date or consider the effects of lease modifications during the comparative periods. Entities may record a cumulative adjustment to the opening balance of retained earnings in the year of adoption. Compliance with the … 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. PwC’s Leases guide is a comprehensive resource for lessees and lessors to account for leases under the new leases standard (ASC 842). 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. Consider if any plans to go public might influence a decision to use a practical expedient designed for private companies only. 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. var plc461032 = window.plc461032 || 0; A further expedient provided in ASC Topic 842 applies only to private entities. 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. Provide the disclosures required by ASC 842 for 2017 and 2018. 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' }}); To address this complexity, the Financial Accounting Standards Board (FASB) has provided several practical expedients entities may use for the transition.Effective dates 1. Under ASC 842, there will be no effect to the income statement, EBITDA, or debt When making the transition to the new lease standard, organizations must choose between two possible implementation methods, both involving the modified retrospective approach: 1) the “comparative method” and 2) the “effective date method.” The more costly and time-consuming approach involves applying the new standard as of the beginning of the earliest period presented within the financial statements (comparative method). Of course, if so elected, the lessor would have to apply the same guidance to an entire class of underlying assets. For example, if an entity determined that a lease was classified as an operating lease under ASC 840, the entity can carry forward that classification when applying the … The entity would not: ... be applied or how helpful it would be for relieving the costs of applying the separation and allocation guidance in ASC 842. Evaluate implementation approaches including the available practical expedients, particularly those intended to simplify transition and those used in determination of the discount rate. In ASC Topic 842, FASB provides entities relief from the burden of having to determine whether leases are included in existing or expired contracts at the transition date. Guide to auditing the implementation of ASC 842, Leases | 1 . 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. Evaluate the nature and extent of related-party leases, particularly those with terms and conditions that are not formally documented. (function(){ • 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 Realize that determining the discount rate is complex Such rights may be permanent or limited and may be exclusive or shared with other entities. var abkw = window.abkw || ''; A privately held company can elect to use a risk-free rate (e.g., U.S. Treasury bill rate) to discount the lease payments and avoid the more complicated and problematic determination of a risk-adjusted discount rate (e.g., its incremental borrowing rate). 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. Prior periods presented would continue under guidance in ASC 840. var div = divs[divs.length-1]; ASU 2018-11 amends ASC 842 so that entities may elect not to recast their comparative periods in transition (the “Comparatives Under 840 Option”). var plc289809 = window.plc289809 || 0; Almost all entities with operating leases will experience some impact from the eventual adoption of the new lease accounting standard. Lessees also have the ability to make an accounting policy election by class of underlying asset to not record a right-of-use asset and lease liability for short-term leases, which are defined as leases with a lease term of 12 months or less. (function(){ 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. In some cases, it may be from the commencement date to the end of the useful life of the asset. })(); 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. • Provide the disclosures required by ASC 840 for the comparative periods. The timing and pattern of transfer for the lease component and associated nonlease components are the same. 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 || []; document.write('<'+'div id="placement_459481_'+plc459481+'">'); 2018-11 July 2018 Targeted Improvements ... and reco gnize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption consistent with preparers’ requests. Prior to ASC Topic 842, the diversity of accounting practice with respect to such easements was such that some entities followed the guidance provided in ASC Topic 350 or ASC Topic 360, “Property, Plant, and Equipment,” while others treated such land easements as leases and applied the provisions of ASC Topic 840. 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. 17. 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. Some companies might have concerns about a perception of additional leverage with ROU assets and operating lease liabilities now on the balance sheet. 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. 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. 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. The new treatment should improve financial reporting by making it easier for companies to change to a method that better reflects how … The impact on lessees. All other entities (e.g., privately held) will have to comply with the new guidance for annual periods beginning after December 15, 2020 (including all interim periods within fiscal years beginning after December 15, 2021). If you were worried about comparative reporting, the new transition option is a relief. The purpose of this article is to summarize and discuss the expedients provided in the standard and its recent amendments. 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. Companies should determine whether a lease administration software or enterprise resource planning module is appropriate or if leases and related journal entries will be administered using spreadsheet software or other manual systems. 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. div.id = "placement_461033_"+plc461033; The weighted-average discount rate, segregated between those for finance and operating leases, must also be disclosed. Consistent with its goal to reduce the cost and complexity of implementing this standard and others (i.e., its simplification project), FASB has endeavored to provide entities with several “practical expedients” within the standard itself, as well as in subsequent updates. 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. Public company lessees also invested significant resources in the determination of appropriate discount rates, typically the incremental borrowing rate, to apply to leases upon implementation of Topic 842. If not elected, the lessee must apply other guidance with respect to its accounting treatment of nonlease components (e.g., application of ASC Topic 350, “Intangibles—Goodwill and Others”). 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. Agreements that contain a lease under Topic 842 characterizes operating lease liabilities as liabilities. The eventual adoption of the effective/adoption date to determine the information available at the inception of the leases years! 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