Determining the appropriate discount rate to use under FASB 842 and IFRS 16 is a little bit like being between a rock and a hard place.

According to the new lease accounting standards, which private companies have until the end of the year to implement in order to be in compliance, lessees need to recognize a lease liability on the balance sheet using either the rate implicit in the lease or their incremental borrowing rate (IBR).

At first glance, this choice appears straightforward enough. But actually this aspect of the new guidance is causing more than just a little confusion and frustration. So much so, that the topic is open for discussion in FASB’s next roundtable meeting scheduled for mid-May. (The meeting was originally slated for early April, but with concerns related to the coronavirus crisis, it was pushed back.)

Before getting into the specifics about what makes this discount rate determination so perplexing, private companies reporting under FASB 842 should be aware that the board offers an alternative in the form of a practical expedient. 

Yes, Accountants, there is a place for spreadsheets in your ASC 842 implementation process. 

For some, that bit of news is as welcome as Virginia being assured there is a Santa Claus. Especially with all the headlines declaring lease accounting software as the one and only answer to the challenges of implementing the new lease accounting standards. One article flat out claims the days of using Excel are over!

It’s easy to see why spreadsheets are so beloved. They’re inexpensive, versatile and have been around for ages.

But it’s also understandable that many implementers gave up on spreadsheets in favor of an automated solution. In fact, 72% of public companies that have finished implementation either upgraded an existing system or purchased new lease accounting software. Early on, they realized the magnitude, complexity and significance of the task before them.

Whether you’re reporting under FASB 842, IFRS 16 or GASB 87, private companies and governmental entities can learn valuable lessons from companies that have already completed the transition.

The new FASB lease accounting guidelines put operating leases front and center. 

In preparing for the transition to the new lease accounting standard, most of the focus has been on the changes to the actual accounting for leases. In a nutshell, virtually all leases with terms over 12 months are required to be recognized on the balance sheet with an ROU asset and corresponding lease liability. For private companies, the deadline is January 2021.

But there’s another change within the 400-plus pages of FASB 842 that organizations also need to pay close attention to from the get-go.

And that’s the disclosure requirements under the new lease accounting standard.  

Reporting entities should be aware that the new disclosure requirements have expanded significantly over the old guidance for both lessees and lessors. This increase in what’s required means you need to consider all the disclosures early in your implementation process--even before settling upon an automated lease accounting software solution.

Why did FASB increase the disclosure requirements?

In keeping with the overall objective of the new FASB lease accounting rules to bring transparency, insight and clarity to a company’s financial statements, the Board also revised what it expected entities to disclose regarding their leasing commitments.

According to FASB ASC 842, the disclosures should “enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.”

So to satisfy this objective, lessees (lessor disclosures will be discussed at a later date) must disclose information about their leases that’s both qualitative and quantitative as well as explanations about the assumptions used in the process. 

In the absence of hard and fast “bright lines,” the new guidance allows a reporting entity to apply judgment when it comes to how much detail to include in its disclosures and how much emphasis each of the various requirements receives.

“A lessee shall aggregate disclosures so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or by aggregating items that have different characteristics.” In other words, lessees should provide information that is neither extremely detailed nor overly high level but simply enough to present a straightforward understanding of its current and future leasing obligations. 

Furthermore, the disclosures of companies with extensive leasing activities are expected to be more comprehensive than those of a company with fewer leases.    

Before getting into the new disclosures for lessees, you should know that FASB eliminated some of the current disclosures:

• The total of minimum rentals that are to be received on noncancelable subleases in the future. This applies to both operating and capital leases as of the date of the financial statements.
  
  
• For each financial statement presented, the gross amount of assets recorded under capital leases by major classes.
  
  
• For sale-leaseback transactions when the seller-lessee applied the deposit or financing method, the future minimum lease payments and minimum sublease rentals aggregated at the date of the financial statements and for each of the five succeeding fiscal years.

One of the topics in the new FASB guidelines getting a lot of attention these days involves embedded leases--those provisions that are often hidden or buried in a larger service or supply contract that grant a lessee the right to use an asset for a specified term.

In fact, in a 2018 KPMG poll, over 60% of respondents indicated that the most significant challenge they encountered in ASC 842 implementation was identifying embedded leases.

The requirement to identify embedded leases is not altogether new. Under ASC 840, embedded leases, like operating leases, were to be included only in the footnotes. And because they had little impact on financial statements, many companies may not have been diligent in their efforts to identify all their embedded leases. 

However, the new lease accounting standard calls for virtually all leases over 12 months to be recognized on the balance sheet with a right-to-use lease asset and lease liability. 

It doesn’t matter if an embedded lease is classified as an operating lease or a finance lease, the accounting for it must happen on the balance sheet.

The recognition of embedded leases has financial professionals concerned for several reasons:

• As noted above, these types of leases were often overlooked as simply part of a service agreement or treated as operating leases--which up till now were accounted for off-balance sheet. There could be a myriad of embedded leases that need to be discovered.
• Locating them is difficult, partly because many contracts with an embedded lease may not even contain the words “lease” or “rent.”
• Failure to include an embedded lease could possibly have a material impact on a company’s financial statements. 

Private companies in the midst of implementing the FASB guidelines for compliance, need to take the identification of all their embedded leases seriously.

The buzz surrounding the new lease accounting rules generally focuses on operating leases. All those leasing arrangements that were previously buried in the footnotes of a company’s financial statements are now required to be recognized with a lease asset and lease liability on the balance sheet.

No doubt about it. That one change is definitely buzzworthy. After the FASB announced its plans, financial forecasters estimated that singular move could increase balance sheets of U.S. publicly traded companies by as much as $2 trillion and could make many of them appear more leveraged than under the legacy guidance.

But before you can begin the new--and somewhat complicated--accounting for those operating leases, you have to complete the classification of all your leases--including any contracts that may contain an embedded lease.

The FASB’s legacy guidance uses a two-model approach: operating leases and capital leases. FASB ASC 842 also uses a dual model approach: operating leases and capital leases with a new name--finance leases.

Regarding capital leases, the FASB did more than change the name. They made slight changes to the four criteria used to determine whether a lease is a finance lease or not and added a fifth one.

The actual accounting for finance leases under the new lease accounting rules is not much different from the way capital leases were handled under the old standard.

So if the accounting for a finance lease is practically the same as it has been and virtually all leases over 12 months have to be recognized on the balance sheet, should it really matter how your leases are classified? 

Yes. Because the correct accounting of a lease begins with the correct lease classification.

“Just the facts, ma’am.” Sergeant Joe Friday uttered some version of those words in just about every episode of Dragnet. So taking a cue from the iconic detective…

Here’s just the facts about GASB 87.

Overview

The Governmental Accounting Standards Board (GASB) issued Statement No. 87, Leases, in June 2017. Like its counterparts in the non-governmental sector, the governing board’s objective was to improve transparency and comparability in the accounting and financial reporting of leases. 

In a news release GASB Chairman David A. Vaudt explained, “The Board’s new leasing guidance better aligns the accounting and financial reporting of these arrangements with their economic substance.”

The primary way all three boards aimed to achieve this goal was by moving operating leases to the balance sheet. 

Whereas the Financial Accounting Standards Board (FASB) maintained its two-model approach for the classification of leases, the International Accounting Standards Board (IASB) established a single-model approach with IFRS 16, eliminating the operating lease classification. This shift was based on the thinking that all leases are basically financing arrangements for the right to use an underlying asset.

Like IFRS 16, the new lease accounting standard from the GASB uses the single-model approach. This differs from the existing GASB guidance which uses a dual-model approach more closely mirroring FASB 13 (which dates back to 1976 even before the GASB was formed). 

Through the years the GASB has issued concept statements that define terms such as asset, lease and liability and has periodically evaluated their standards to determine if they still worked for governments or if updates were called for.

But GASB 87 presents the biggest change to lease accounting for governmental entities.