There is a new set of Accounting Standards that will impact the financial statements of most businesses as early as 2019. FASB ASC 842 will now require private and publicly traded companies to include lease obligations on their Balance Sheets. Publicly companies will have to comply by 2019 but private companies have until the fiscal year of 2020 to report the new standard. Lease Administration Software is even available for those companies that want to adopt FASB 842 early.
FASB which stands for Financial Accounting Standard Board which is an independent private not for profit organization and has the authority to establish and interpret generally accepted accounting principles (GAAP).
Under FASB ASC 842 for the first time in history lessees must recognized lease assets and lease liabilities on the Balance Sheet. Lessees will recognize a (ROU) right of use asset and a lease liability for those leases on the Balance Sheet as a non debt liability. This does to apply however to leases that are less than 12 months.
Lets look at an example of an operating lease. This is the part where I will get technical with Accounting.
In this example, a lessee accounts for a simple operating lease for a building with 10 equal annual lease payments. Assume the following:
- The lessee, A, signs an agreement with the lessor, B, to lease a building on Jan. 1, Year 1
- The lease period (no renewal options) is 10 years
- The annual lease payment, due on Dec. 31, is $162,745
- The lessee’s incremental borrowing rate is 10%
- The present value of lease payments is $1 million
- Initial direct costs are $0
- The remaining economic life of the asset is 20 years
- The estimated fair value of the building is $2 million
- The underlying asset is transferred back to lessor at end of the lease term.
Right of Use Asset ROU Dr $1,000,00
Lease Liability Cr $1,000,000
To Record the inception of the lease
This is the present value of an ordinary annuity for $162,745 per year at 10% for 10 years which is $1,000,000.
12/31 year 1
Lease Expense Dr 162,745
Lease Liability Cr 100,000
Right of Use Asset Cr 62,745
To record Lease Expense
This is the lease expense of 162,745 at 10 years using the straight line method.
Accrued interest on the lease is $1,000,000 at 10% is $100,000
The value of the right of use asset is now 937,255 which is $1,000,000 minus the $62,745.
Now we will record the payments for 12/31 year 1
Dr Lease Liability 162,745
Cr Cash 162,745