Authored by: Phil Santarelli
The adoption of Accounting Standards Codification (ASC) 842, Leases, makes accounting much more complex for traditional operating leases. Not surprisingly, the disclosure requirements are quite extensive. Additionally, the new leases standard has specific requirements as to how leasing activity is to be presented in the basic financial statements. In this final article on the new leasing standard, we examine these new requirements.
Statement of financial position
ASC 842 requires each type of lease, operating or finance type, to be displayed in the statement of financial position. The related right to use asset must be presented separately from other assets, as well as from each other. The corresponding lease liabilities also must be presented separately from other liabilities and from each other.
The classification of the assets and liabilities as current or noncurrent will be subject to the same considerations as other assets and liabilities.
If an entity chooses not to provide the display noted above, the entity may disclose which line items in the statement of financial position contain the related assets and liabilities for operating leases and finance type leases, and the relevant balances.
An entity is prohibited from combining the assets and liabilities of the different types of leases in the same line item.
Statement of comprehensive income
There are no substantive changes from current practice related to display in this statement. For finance type leases, the related interest expense need not be separately stated and the amortization of the right to use asset may be combined with other amortization expense.
The rent expense from operating leases needs to be included in the income from continuing operations.
Statement of cash flows
Repayments of the principle portion of finance leases are classified as financing activities and related interest expense is classified in the same manner as interest paid as required in Topic 230. Operating lease payments are classified within operating activities, except for expenditures to make the asset ready for use – such as moving and related set up costs, which should be classified as investing activities. Related variable lease payments and payments related to short term leases will be classified in operating activities.
The overall objective of the disclosure requirements is to enable users of the financial statements to understand the “…amount, timing, and uncertainty of cash flows arising from leases.”1 A lessee will need to disclose quantitative and qualitative information about its leases, the related significant judgments made in measuring leases and the amounts recognized in the financial statements. An entity needs to consider the required level of detail to meet this objective, including the extent of aggregation or disaggregation used in the disclosures.
Although ASC 842 is considered to be a principle based standard there are specific required disclosures as follows:
- Information about the nature of its leases, including:
- A general description of those leases.
- The basis and terms and conditions on which variable lease payments are determined.
- The existence and terms and conditions of options to extend or terminate the lease. A lessee should provide narrative disclosure about the options that are recognized as part of its right-of-use assets and lease liabilities and those that are not.
- The existence and terms and conditions of residual value guarantees provided by the lessee.
- The restrictions or covenants imposed by leases (for example, those relating to dividends or incurring additional financial obligations).
- A lessee should identify the information relating to subleases included in the disclosures provided in (a.1) through (a.5), as applicable.
- Information about leases that have not yet commenced but that create significant rights and obligations for the lessee, including the nature of any involvement with the construction or design of the underlying asset.
- Information about significant assumptions and judgments made in applying the requirements of this Topic, which may include the following:
- The determination of whether a contract contains a lease (as described in paragraphs 842-10-15-2 through 15-27)
- The allocation of the consideration in a contract between lease and nonlease components (as described in paragraphs 842-10-15-28 through 15-32)
- The determination of the discount rate for the lease (as described in paragraphs 842-20-30-2 through 30-4).2
An entity shall also disclose information related to its total lease cost, including amounts recognized in the income statement and costs capitalized related to leases and the related cash flows. This is accomplished by providing the following disclosures:
- Finance lease cost, segregated between the amortization of the right-of use assets and interest on the lease liabilities.
- Operating lease cost determined in accordance with paragraphs 842-20-25-6(a) and 842-20-25-7.
- Short-term lease cost, excluding expenses relating to leases with a lease term of one month or less, determined in accordance with paragraph 842-20-25-2.
- Variable lease cost determined in accordance with paragraphs 842-20-25-5(b) and 842-20-25-6(b).
- 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 in accordance with paragraph 842-40-25-4.
- 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 noncash information on lease liabilities arising from obtaining right-of-use assets
- Weighted-average remaining lease term
- Weighted-average discount rate.3
A lessee must also disclose the future lease payment requirements, undiscounted, for the first five years and the total for the remaining lease term. This requirement, of course, is a requirement of the current lease standard.
If relevant, a lessee will separately disclose its lease transactions with related parties and information related to its short term leases commitments. If an entity elects the practical expedient for not separately accounting for nonlease components in a lease contract, this policy and information for which classes of assets the election has been made must be disclosed.
The new disclosure requirements will potentially require new process and controls, especially related to the accounting for operating leases. ASC 842, provides an example of how the quantitative disclosure could be displayed in Example 6, ASC 842-20-55-4. Examples of related qualitative disclosures are not provided.
Entities will need to consider how and in what format the required information should be provided, possibly using its current lease footnote as a starting point and building from there. The disclosures are subject to audit and, for issuers, will be in scope for management’s report on internal controls.
For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.
1 ASC 842-20-5--1
2 ASC 842-20-50-3
3 ASC 842-20-5-4