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 ASC 842 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.
New disclosure requirements under FASB 842
Although ASC 840 includes some of the following disclosures for capital leases, the new lease accounting standard applies to all leases regardless of their classification--even leases that aren’t required to be recognized on the balance sheet, such as short-term leases. Bear in mind disclosures are also subject to audit.
The guidelines do not call for a specific format for lessee disclosures. Since the examples in ASC 842 are in tabular form, most companies will likely use that format for disclosure reporting.
The list below includes the current disclosures still in effect and the ones added (in bold) to the new lease accounting standard.
Information about the nature of leases, including any subleases:
- A general description of leases
- The basis and terms and conditions on which variable lease payments are determined
- Any terms and conditions of options to extend or terminate leases--lessees need to provide a narrative disclosure which distinguishes between the options recognized as part of its ROU assets and lease liabilities and the ones that are not recognized
- The terms and conditions of any residual value guarantees the lessee provided
- The restrictions or covenants imposed by leases--for example, related to dividends or incurring additional financial obligations
- Information concerning leases that have not yet begun but impose significant rights and obligations for the lessee. This includes the nature of any involvement with the construction or design of the underlying asset.
Information about significant assumptions and judgments, including:
- The determination of whether a contract contains a lease
- The allocation of the consideration in a contract between lease and non-lease components
- The determination of the discount rate for the lease
- Lease transactions between related parties
- The election of the practical expedient relating to short-term leases
- The election of the practical expedient relating to separating lease components from non-lease components. This should also include which class or classes of underlying assets the practical expedient was applied to.
- The election of the practical expedient to not restate comparative periods in the period of adoption
- The election of the transition practical expedient relating to hindsight
- The election of the transition practical expedient “package”
The amounts recognized in the financial statements relating to leases:
- Finance lease cost, segregated between the ROU amortization and interest on the lease liabilities
- Operating lease cost
- Short-term lease cost, excluding expenses relating to leases with a lease term of one month or less
- Variable lease cost
- Sublease income, disclosed on a gross basis, separate from the finance or operating lease expense
- Net gain or loss recognized from sale and leaseback transactions
- Amounts segregated between those for finance and operating leases for the following items:
- Cash paid for amounts included in the measurement of lease liabilities, segregated between operating and financing cash flows
- Supplemental non cash information on lease liabilities arising from obtaining ROU assets
- Weighted-average remaining lease term
- Weighted-average discount rate
- Maturity analysis of lease liabilities--this needs to show the undiscounted cash flows on an annual basis for each of the first five years after the balance sheet date and a total of the amounts for the remaining years. This should also include a reconciliation of the undiscounted cash flows to lease liabilities recorded on the balance sheet.
Planning with disclosures in mind
As mentioned before, it’s important to understand the disclosure requirements early in your implementation process and not relegate them to the back burner. There are several reasons for this:
- Because disclosures are an essential output, the capability to integrate disclosure information is a must-have feature of a lease accounting solution. As you compare providers, you’ll want to make sure the software meets your needs with regards to disclosure reporting.
- As you’re gathering data for the accounting portion of your financial statements you can also collect the information you need to support the disclosures. This improves efficiency and reliability.
- Since disclosures can be audited, it’s equally critical that they are as complete and accurate as the other parts of your financial statements.
Reporting entities have much to deal with during the complex and time-consuming implementation process. Misconceptions or misguided planning complicates it even further. Here are a few caveats to pay attention to.
- Take into consideration the materiality of disclosures.
- Know that the interim disclosure requirements apply to more than just the first quarter of adoption.
- Remember that both lessees and lessors are affected by the new disclosure requirements.
- Don’t wrongly assume disclosures apply only to leases reported on the balance sheet.
- Include information about any practical expedients you’ve elected.
Many public companies ignored the disclosure requirements until nearly the end of their implementation process and then had to scramble to be in compliance. With nine months to go till the deadline, it’s a good time to understand the FASB 842 disclosures and their impact on your reporting.
If you have questions about this part of compliance or any other challenge you’re dealing with because of the new lease accounting standard, we’d be happy to talk with you. Our team has over 20 years of experience in lease accounting and lease management and has already helped hundreds of companies with implementation of the new FASB lease accounting standard.