In 2016, the FASB released ASC 842, which dealt with the new accounting treatment required for leases.
According to the FASB, this Standard (or “Topic”) was introduced to “increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.”
ASC 842 was also a response to dubious accounting treatment of “off balance sheet liabilities,” which were used to obfuscate some entities’ real accounting position – think Enron, for example.
Under ASC 842 all companies – public companies are already obligated to account for leases and private companies will have to comply soon – must disclose leases on the balance sheet, with a right-of-use asset and a lease liability.
With the preparers of ASC 842 wanting to encourage transparency and comparability, it goes without saying that the disclosure requirements around ASC 842 are a critical part of the Topic. These disclosures ensure that key information is presented to the user of the financial statements and allows such users to assess the amount, timing, and uncertainty of cash flows arising from leases.
Key disclosure requirements for lessees according to ASC 842
First off, ASC 842 mandates what should be included in the balance sheet (or Statement of Financial Position, to be more accurate) of a lessee [842-20-45-1]:
- Finance lease right-of-use assets and operating lease right-of-use assets should be presented separately from each other and from other assets
- Similarly, finance lease liabilities and operating lease liabilities should also be presented separately from each other and from other liabilities
In the income statement, or Statement of Comprehensive Income, a lessee must show the following [842-20-45-4]:
- For finance leases: interest expense on the lease liability and amortization of the right-of-use asset: this can be presented however the entity presents other interest expense and depreciation or amortization of similar assets
- For operating leases, the lease expense must be included in the lessee’s income from continuing operations
According to ASC 842, a company must disclose both qualitative and quantitative information about the following [842-20-50-1]:
- Its leases, including a general description to provide more information to users
- The significant judgments made in applying the requirements of ASC 842 to these leases
- The amounts recognized in the financial statements relating to these leases
Qualitative and quantitative disclosures
Examples of qualitative disclosures as mentioned in the Topic include:
- A general description of an entity’s leases
- The basis, terms and conditions according to which variable lease payments are determined
- Information regarding the option to extend or terminate leases
- Restrictions or covenants imposed by lease agreements
- Information about leases that have not yet commenced but that create significant rights and obligations for the lessee
- Significant assumptions and judgments made in applying the requirements of this Topic, including:
- Determining of whether a contract contains a lease
- Allocation of the consideration between lease and non-lease components
- How discount rates were determined
While examples of quantitative disclosures are:
- Finance lease cost, segregated between the amortization of the right-of use assets and interest on the lease liabilities
- Net gain or loss recognized from sale and leaseback transactions
- Weighted average remaining lease term
- Weighted-average discount rate
Additionally, lessees are required to disclose:
- Separate maturity analyses of both finance lease liabilities and operating lease liabilities Including undiscounted cash flows on an annual basis
- For a minimum of each of the first five years and the total of the amounts for the remaining years
- A reconciliation of the undiscounted cash flows to the finance and operating lease liabilities as shown on the face of the balance sheet
- Lease transactions with related parties
- Disclosure around the accounting treatment of short-term leases
Common pitfalls in lease disclosure planning
All this disclosure can seem overwhelming. However when taken down to a practical level, it’s often not as daunting as it first appears. Having said this, there are some common pitfalls to avoid when planning your ASC 842-compliant lease disclosures:
Not giving disclosure requirements a “seat at the table” when performing technology selection
Most companies will be unable to manually keep track of their leases, nevermind account for them correctly under ASC 842, without a technology solution to assist them. Automated lease accounting software for example can do all the heavy lifting for you when it comes to recognizing, accounting for and presenting leases.
When selecting the right technology for you, make sure that it takes care of disclosure too. A solution that does not do this is like walking in the rain with a hole in your umbrella – there’s no point in having it if it cannot do the full job.
Believing the new disclosure requirements only affect lessees and not lessors
The new disclosure requirements affect lessors too, which should not be forgotten. These are dealt with in ASC 842 as follows:
Qualitative disclosures: ASC 842-30-50-3(a), 842-30-50-4, and 842-30-50-7
Quantitative disclosures: ASC 842-30-50-5 through 50-6 and 842-30-50-8 through 50-13
Believing these requirements don’t apply to you
For good or for bad, the requirements of ASC 842 – including disclosure requirements – apply to all U.S. companies, public or private.
While there might be a temptation to stick your head in the sand, ASC 842 isn’t going away. The good news is that preparing properly now will remove all the headache and stress for when your financial information has to be accounted for according to this new standard.
Benefits of lease accounting software for efficiency and accuracy of disclosures
As we’ve seen, staying on top of ASC 842 disclosures is no walk in the park. But with the right technology solution in your corner, you can rest assured that all of these disclosures – as well as other elements of ASC 842 compliance – are taken care of.
For example, with Trullion’s automated AI-enhanced lease accounting software, you can ensure that consolidated reports can be produced in minutes; errors are reduced or eliminated as human error is taken out of the equation; any changes are populated throughout the system automatically, removing the need for manual adjustments; and disclosures are completely streamlined, making ASC 842 compliance a pleasure.
Want to see it for yourself? Book a demo now.