40 MARCH / APRIL 2017 FEATURE In February 2016, a new accounting standard was issued that will dramatically change the accounting for leases, particularly for lessees. In general, the new standard will require most leases to be recorded on the balance sheet, which will have a dramatic impact on any company that has a large number of operating leases, particularly longer-term real estate leases. This standard will affect banks that are lessees of offices and equipment by requiring the leases to be recorded on the balance sheet, as well as affecting credit departments of banks as they evaluate and monitor credit risk for customers. The new standard is effective for public companies for years beginning after Dec. 15, 2018, and for private companies for years beginning after Dec. 15, 2019, with early adoption permitted. General Changes That Affect Lessors and Lessees Upon implementation, lease contracts will have to be segregated into lease and non-lease components. This standard only applies to the lease components in a contract. Non-lease components are accounted for under other accounting standards. Consideration identified in the contract will have to be allocated between lease components and non-lease components, based on the relative fair value of the components on a stand-alone basis. The standard retains a dual accounting methodology for different types of leases, similar to prior accounting guidance. If a lease meets any of the following criteria, it will be classified as a finance lease (for a lessee) or a sales-type lease (for a lessor). If none of these criteria are met, the lease will be classified as an operating lease by both the lessee and lessor. Criteria: 1. Transfer of ownership; 2. Option to purchase that the lessee is reasonably certain to exercise; 3. Lease term is for the major part of the remaining economic life; 4. Present value of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the asset; 5. The underlying asset is of such specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term. The first four criteria are similar to existing accounting guidance that currently distinguishes a capital lease from an operating lease. However, the specified percentage criteria have been eliminated and replaced with a more judgmental approach. The fifth criterion is new. Accounting for Operating Leases by Lessors Since the accounting for operating leases by a lessee is the most dramatically changed by this standard, the remainder of this article will focus on this segment of the new standard. At the initial measurement date of a lease, a lease liability will be recorded for the present value of lease payments not yet paid. Generally, variable lease payments (e.g., increases based on an index) are not included in the determination of the lease liability, but rather are recorded when incurred. Additionally a “right-of-use” asset is recorded for the amount of the lease liability, plus any lease payments made before the commencement date of the lease, less any lease incentives received by the lessee, plus any initial direct costs incurred by the lessee. After the initial measurement, lease expense in a single amount will be recorded for the remaining cost of the lease, allocated generally on a straight-line basis. The right-of-use asset is accreted based on the interest method and reduced by the lease expense recorded. The lease liability is reduced on the interest method as payments are made by the lessee. Disclosures have been expanded to provide additional qualitative and quantitative information about the nature of leases, terms and conditions of variable lease payment determination, terms and conditions of options to extend or terminate a lease, terms and conditions of any residual value guarantees, any restrictive covenants, and significant judgments about allocating consideration between lease and non-lease components. Changes Coming for lease accounting Diane M. Zimmerman Director Baden Gage & Schroeder LLC dzimmerman@badencpa.com Article author Baden Gage & Schroeder LLC is an associate member of the Indiana Bankers Association.
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