Know Your STANDARDS: What follows are updates on a variety of topics from CalCPA's Accounting Principles and Assurance Services Committee. For more information on the committee, visit calcpa.org/apascommittee Accounting for Leases.

• Author: Malhotra, Ravi
• Position: AP&AS NEWS

Accounting Standards Codification (ASC) 842, Leases, is effective for private companies and other not-for-profit entities that have not issued (or made available for issuance) financial statements that reflect the new standard as of June 3, 2020, are required to adopt the new leases standard for annual periods beginning after Dec. 15 and interim periods in annual periods beginning after Dec. 15, 2022. Early adoption is permitted for all entities.

This is expected to have a significant impact on most entities' balance sheets, considering how prevalent and routine leasing is to most businesses.

The FASB issued the new standard to increase transparency and comparability among entities by recognizing leases on the balance sheet and providing more information about leasing arrangements so that users can assess the amount, timing and uncertainty of cash flows from leases.

ASC 842 allows for two transition methods upon adoption:

* Modified retrospective transition approach: ASC 842 is applied to any leases existing at the beginning of the earliest comparative period presented in the financial statements, as well those commencing after that date, but prior to the effective date, with prior periods being restated; or

* Prospective transition approach: ASC 842 is applied only in the year of adoption, whereby the company would not need to apply the new guidance to its leases in the prior comparative periods. Public companies have already adopted the new standard and, based on the feedback and discussions in the past two years, it's understood that adopting the new lease standard can be quite complex and time consuming, with many important nuances that can impact the amounts initially recorded.

Definitions

The new standard defines a lease as "A contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment (an identified asset) for a period of time in exchange for consideration." The keys are whether there is an identified asset and whether the arrangement conveys control of the identified asset.

ASC 842-10-15-9 defines identified asset as "An asset typically is identified by being explicitly specified in a contract. However, an asset also can be identified by being implicitly specified at the time that the asset is made available for use by the customer."

ASC 842-10-15-16 also states: "A capacity portion of an asset is an identified asset if it is physically distinct (for example, a floor of a building or a segment of a pipeline that connects a single customer to the larger pipeline). A capacity or other portion of an asset that is not physically distinct (for example, a capacity portion of a fiber optic cable) is not an identified asset, unless it represents substantially all of the capacity of the asset and thereby provides the customer with the right to obtain substantially all of the economic benefits from use of the asset."

Lease Identification It's more important to determine whether a contract is a lease or contains a lease under the new leases standard than it was under ASC 840, as an incomplete population of leases (as discussed later in this article) could materially misstate financial results. Under ASC 842, lessees must recognize a right-of-use asset (ROU) and lease liability on their balance sheets for most leases.

Entities will need to apply judgment to determine whether the contract includes an identified asset and whether the customer has the right to control the identified asset for a period in exchange for consideration. When determining whether an arrangement is or contains a lease, entities evaluate, among other things, whether the customer has the right to control the use of the identified asset.

Once an arrangement is determined to be a lease or a contract containing a lease, you will need to determine the commencement date, lease term, lease payments and the discount rate, as you will need this information to determine lease classification and calculate the amounts initially recognized on the balance sheet.

Lease Classification

Lease classification is important because the pattern of expense recognition is different for finance vs. operating leases. The lessee will follow the same process for classifying the lease as under the existing standard ASC-840.

While the criteria to determine whether a lease is a...