Lease accounting received an accounting overhaul with the recent release of the Financial Accounting Standards Board (FASB)'s Accounting Standards Update 2016-02 Leases (Topic 842). The new standard most significantly changes lessee accounting compared to existing US GAAP, but also has some targeted changes for lessor accounting. Overall, ASU 2016-02 seeks to improve transparency to the economics of lease transactions and bring lease accounting into line with other recently released accounting standards updates, such as the changes to Revenue from Contracts with Customers (Topic 606).

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purchase option will be exercised, those payments
should be included in the calculation. Assets and
liabilities arising from finance leases and operating
leases must be presented or disclosed separately
from each other and other assets and obligations.
Consistent with previous guidance, an entity
should exclude variable lease payments from the
measurement of the asset and obligation recognized.
Lease payments, including fixed payments, in-
substance fixed payments and those payments
based on an index or rate, are measured based on
the index or rate that exists at lease commencement.
In certain circumstances, the lease payment may also
be adjusted for lease incentives, purchase options,
penalties and residual value guarantees. Lessees
that have leases with lease terms for accounting
purposes of less than one year can elect to recognize
lease expense on a straight line basis over the lease
term without recognizing the liabilities and assets
associated with their lease.
Measurement of the lease asset and liability will
require determining an appropriate discount rate.
Similar to existing guidance, a lessee will look to
the rate implicit in the lease or, if that rate is not
determinable, its incremental borrowing rate to
discount the lease payments. A private company will
have a practical expedient to utilize the risk-free rate
instead of determining the rate implicit in the lease or
its incremental borrowing rate. The election to use the
practical expedient is anticipated to result in a larger
lease asset and liability.
Lease accounting received an accounting overhaul
with the recent release of the Financial Accounting
Standards Board (FASB)’s Accounting Standards
Update 2016-02 Leases (Topic 842). The new
standard most significantly changes lessee
accounting compared to existing US GAAP, but also
has some targeted changes for lessor accounting.
Overall, ASU 2016-02 seeks to improve transparency
to the economics of lease transactions and bring
lease accounting into line with other recently released
accounting standards updates, such as the changes
to Revenue from Contracts with Customers (Topic
606).
Lessee Accounting
Lessees will now be required to recognize lease assets
and liabilities on the balance sheet for leases with a
lease term for accounting purposes that is longer than
12 months. As in earlier guidance, a lessee evaluates
a lease to classify it in one of two types that, under
the new standard, are referred to as finance and
operating leases.
In a concept similar to existing guidance, when the
lessee is reasonably certain a renewal option or
March 2016
FASB Unveils New Leasing Standard

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Some simplifications were made to prior proposals.
The new standard eliminates the previously proposed
distinction between leases of real estate and leases
of equipment in favor of lease classification tests
distinguishing finance and operating leases that are
similar to existing guidance.
Processes may have to be implemented to identify
all leases and address the various requirements
and allocations within the new standard. This may
necessitate revisiting accounting or enterprise
resource planning software to account for the new
changes.
Lessor Accounting
Lessor accounting remains fundamentally similar to
previous guidance, however the concept of leveraged
leases was eliminated prospectively. Changes were
made to reflect new terminology; capital leases are
called finance leases in the new standard. There is also
additional guidance related to revenue recognition.
The changes coming to revenue recognition will
affect accounting for sale and leaseback and other
arrangements and may require entities to separately
account for nonlease components in contracts that
include a lease.
Determining if a Contract Contains a Lease
Evaluating whether a contract contains a lease takes
on a new significance for lessees under Topic 842
because a contract containing a lease will result in
capitalization of an asset and a liability. In contrast,
under existing lease guidance there was no balance
sheet impact for an operating lease, therefore the
distinction between whether a contract was an
operating lease or service agreement was typically
not significant.
Entities will evaluate whether a contract contains a
lease based on a new definition, which states that
a contractual element that gives an entity the right
to control an asset for a period of time in exchange
for consideration is a lease. The definition of control
under Topic 842 is consistent with the guidance in the
new revenue recognition standard. The lessee is said
to have control over the asset when it has the right
to obtain substantially all of the economic benefits of
the asset during the term of the lease and the right to
direct the use of the asset.
Evaluating Lease and Nonlease Components
Contracts that contain leases will be required to be
separated into components; those that relate to the
lease and those that are nonlease components. The
most common example of a nonlease component
is maintenance, such as maintaining equipment or
common areas and similar services. In addition to
identifying the lease and nonlease components,
the payments under the contract must be allocated
between the two types of components. Separating
the components is critical because only the lease
component will be accounted for under Topic 842. In
general, a lessor will account for nonlease components
under the new revenue recognition guidance, while a
lessee will not capitalize onto the balance sheet the
amount of payments related to nonlease components.
However, for lessees, ASU 2016-02 creates a
practical expedient that permits an accounting policy
election by asset class that would exempt them
from separating the assets into lease and nonlease
elements. Entities making that election would then
account for the lease components and their related
nonlease components as a single lease component,
resulting in the capitalization of a larger right to use
asset and lease liability.

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The information in this MHM Messenger is a brief summary and may not include all the details relevant to your situation.
Please contact your MHM auditor to further discuss the impact on your audit or audit report.
Sale and Leaseback Transactions
For an exchange to qualify as a sale and leaseback
transaction, the provisions must meet the requirements
for a sale defined in Topic 606. If the sale does not
meet the guidelines, then the seller/lessee and the
buyer/lessor do not account for the transaction as
a sale/purchase. In that situation, both parties must
account for any amount paid for a sale and leaseback
transaction as a financing transaction.
There may be scenarios where transactions that
previously qualified as sale and leaseback no longer
qualify or transactions. For example, sale and
leaseback of equipment in which the seller/lessee has
a purchase option typically meet the requirements
today for sale and leaseback accounting, but will
rarely meet the requirements for sale and lease
back under the new leasing standard. At the same
time, transactions involving real estate and build-to-
suit leasing, may now qualify for sale and leaseback
accounting in situations in which those transactions
would not have qualified for sale and leaseback
accounting under today’s guidance. Entities should
carefully consider how the new rules will affect these
types of sales. For existing sale and leaseback
transactions, entities are not required to reassess
whether the transaction meets the definition of a sale
under Topic 842.
Disclosures
Both lessors and lessees will be required to provide
qualitative and quantitative disclosures about the
amount, timing and uncertainty of cash flows that
relate to leases. The information must be robust
enough to provide users of financial statement more
context about the entity’s leasing arrangements.
Effective Date
Public business entities, not-for-profits that have
issued or are a conduit bond obligor for publicly
traded or over-the-counter securities, and employee
benefit plans required to file with the Securities and
Exchange Commission (SEC) must adopt the new
standard for fiscal years and interim periods beginning
after December 15, 2018. All other entities must adopt
for fiscal years beginning after December 15, 2019
(calendar year 2020) and interim periods beginning
after December 15, 2020 (calendar year 2021). Early
adoption is permitted.
Entities will adopt the changes using a modified
retrospective approach for all leases presented within
the financial statements. Leases will be recognized
beginning in the earliest period presented within the
financial statements. For example, if a non-public
business entity adopts Topic 842 for its December
31, 2020 comparative financial statements, then the
lease assets and liability would be recognized as of
January 1, 2019, (the earliest date presented within
those statements) using the modified retrospective
approach. If a public business entity adopts Topic
842 for its December 31, 2019, comparative financial
statements that present three years, then the leases
would be recognized as of January 1, 2017.
For More Information
If you have specific comments, questions or concerns
regarding the new leasing standard, please contact Hal
Hunt of the MHM Professional Standards Group. Hal
can be reached at hhunt@cbiz.com or 816.945.5610.