Whenever practical expedients are mentioned in casual conversation, my mind typically runs straight to Super Mario Brothers. Not the Goombas and Koopa Troopas, but the warp zones, swiftly moving through the game at record speeds utilizing the shortcuts between worlds. (For those unfamiliar, there are ways to beat the game without playing every level – talk about a time saver!)
While it’s not quite the same as pipe-transporting players through video game realms, the FASB is also offering shortcuts in the application of recording leases under ASC Topic 842 or said another way, providing lessees a practical implementation process.
The first is a “package” of three practical expedients that must be elected together in an all-or-nothing format. This package includes the option to (1) not reassess whether a contract is or contains a lease, (2) not reassess the lease classification (meaning if all prior leases were classified as operating leases in accordance with ASC 840 they will be classified as operating leases, and if all existing leases were classified as capital leases under ASC Topic 840 they will be classified as finance leases), and (3) not reassess initial direct costs. ASC Topic 842 defines initial direct cots as those that could have been avoided had the entity not entered into a lease agreement.
The next practical expedient offered allows lessees to use hindsight in determining the lease term and in assessing the impairment of the entity’s right-of-use assets. The hindsight practical expedient allows lessees to look back at other factors when determining lease terms such as options to buy, terminate, or extend a lease and reassess on a go-forward basis at the time of application. While it might be advantageous for lessees to select the hindsight practical expedient, it can be a very time-consuming process because it must be applied to all leases. Hindsight is available separately from the package of three transitional practical expedients above.
An additional expedient permits lessees to not assess whether existing or expired land easements that were not previously accounted for as leases under ASC Topic 840 are or contain a lease under ASC Topic 842. A land easement (also known as a right-of-way) refers to a right to use, access, or cross another owner’s land for a specified purpose.
Some contracts in place may contain more than just leases. They could have options and agreements to purchase or sell other goods or services which are considered non-lease components such as maintenance activities. These non-lease components are normally identified and accounted for under other applicable Generally Accepted Accounting Principles. However, under the practical expedient election, lessees are given the option to account for each lease component and its related non-lease component as a single lease component. This election must be made by class of underlying asset.
Private entities have an additional expedient available to them. A private company can elect to use a risk-free rate to discount lease payments instead of using an incremental borrowing rate.
These optional practical expedients generally make it easier for lessees to transition from legacy lease accounting guidance; however, mistakes can occur that unintentionally violate the practical expedients during adoption through misapplication. For example, the new lease standard potentially allows entities the ability to reassess whether or not certain contracts are or are not leases. However, if the package of three transitional practical expedients is elected, then lessees should not reassess these contracts at transition, unless the contract was incorrectly assessed under legacy lease accounting guidance.
The practical expedients do not shield lessees from errors in assessment under legacy lease accounting guidance and, therefore, completeness analyses are critical.
While implementation of the new lease accounting standard may not seem as fun as dusting off the Nintendo Entertainment System to defeat Bowser, the FASB has put their own warp zones in place to ease the implementation of the new standards.
Organizations need to find a suitable solution for calculating the FASB ASC Topic 842 right-of-use assets and lease liabilities at the transition date and the subsequent lease accounting. Generally, an Excel-based solution would be appropriate for a noncomplex portfolio of 10 or fewer leases. If the lease profile is more complex or greater than 10 individual leases, management is better served by a lease software solution, such as simpLEASE. In addition to offering our clients simpLEASE, Schneider Downs provides advisory services for the technical aspects of lease accounting.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.