Understanding the New Lease Accounting Guidance

• Date: 01 May 2017
• Published date: 01 May 2017
• DOI: http://doi.org/10.1002/jcaf.22273

48

© 2017 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22273

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Understanding the New Lease

Accounting Guidance

Leonard J. Sliwoski

INTRODUCTION

In early 2016, the

Financial Account-

ing Standards Board

(FASB) issued

Accounting Stan-

dards Update (ASU)

No. 2016-02, Leases.1

The purpose of this

article is to review the

new lease accounting

guidance and com-

pare this guidance to pre-ASU

lease accounting guidance.

PRE-ASU LEASE ACCOUNTING

GUIDANCE

Prior to the ASU, from the

lessee’s perspective, leases were

categorized as either capital or

operating. From the lessor’s

perspective, leases were catego-

rized as either operating, direct-

financing, or sales-type leases.

With capital leases, at lease

inception, the lessee recognized

a leased asset and a related lia-

bility and the lessor recognized

a lease receivable (for both

direct-financing and sales-type

leases) and reduced inventory.

This accounting was based on

the assumption that an asset

was purchased by the lessee

and was sold by the lessor and

financed on an installment

basis. With operating leases, at

lease inception, the lessee did

not recognize an asset or liabil-

ity, and the lessor continued to

recognize the leased asset. This

accounting was based on the

assumption that no lessee asset

purchase, or lessor asset sale,

occurred.

From the lessee’s perspec-

tive, a lease was considered to

be a capital lease if the lease

transferred risks and rewards

of leased asset ownership from

the lessor to the lessee. Specifi-

cally, a capital lease was a non-

cancelable lease that met one or

more of the follow-

ing four quantitative

criteria:

1. The lease agree-

ment specied

that ownership of

the leased asset

transfered to the

lessee.

2. The lease agree-

ment contained a

bargain purchase

option.

3. The noncancelable lease

term was equal to 75% or

more of the expected eco-

nomic life of the leased

asset.

4. The present value of the

minimum lease payments

was equal to or greater than

90% of the fair value of the

leased asset.

Lessees usually preferred

to have leases classified as

operating leases. Without rec-

ognizing a leased asset and

liability at lease inception, the

lessee’s debt-to-equity ratio was

lower, return-on-assets ratio

was higher, and net income

was higher in early lease years.2

The article discusses the new lease accounting

rules in ASU 2016–02. Specifically, the article

discusses how implementation of these rules

prohibits lessees from using leases to obtain

off-balance sheet financing. The article contrasts

ASU 2016–02 lease accounting and previous

lease accounting rules, and provides a numerical

lease example illustrating both previous and new

lease accounting rules. © 2017 Wiley Periodicals, Inc.

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