In our first post of the three-part series on FASB lease accounting readiness, we outlined the first step to FASB and IASB readiness: identify, collect, and load your real estate and equipment leases. In this blog, we’ll discuss steps 2-4, taking the data you have collected and making sense of it.
Step Two – Assumptions In FASB Lease Accounting
In step two, you’ll need to determine the accounting assumptions. A few assumptions to consider are: Cost of Capital and Economic and Fair Value thresholds (for FASB only).
When looking into the Cost of Capital Assumption, the data you need should be in the lease, but if not, you should call on a member of your Treasury department. Additionally, when analyzing the Economic and Fair Value threshold assumptions, these should be approved or validated by your Finance group or Corporate Compliance group.
Step Three – ASC 842 Lease Test
The FASB test has five components. If a lease passes all five, then the lease is treated as an operating lease. If the lease fails any one of the subtests, then the lease is treated as a finance lease. The test outcome determines how the lease is amortized and reported. According to Skoda Minotti, a top tier financial advisor, the requirements are defined below:
Finance Lease Requirements
- Record a right-of-use asset and a lease liability, measured at the present value of the lease payments.
- Recognize interest expense associated with the lease liability separately from amortization of the right-of-use asset in the income statement.
- Classify repayments of the principal portion of the lease liability in financing activities in the statement of cash flows, and payments of interest on the lease liability and any variable payments in the operating activities in the statement of cash flows.
Operating Lease Requirements
- Record a right-of-use asset and a lease liability, initially measured at the present value of the lease payments.
- Record a single-lease cost, calculated so that the cost of the lease is allocated over the term of the lease, generally on a straight-line basis.
- Classify all cash payments within operating activities in the statement of cash flows.
Step 4 – Calculations and Reports
In this step, you will be responsible for generating calculations and reports, which can consist of the weighted average lease term and cost of capital, the present value and related interest/amortization components for the balance sheet and P&L, and short-term lease costs.
Our lease accounting solution, Lucernex, has independent, third-party verification of its compliance with the new FASB ASC 842 and IASB IFRS 16 lease accounting standards. We are ready to assist your organization to classify, capture and upload leases accurately with our built-in, intuitive and user-friendly wizards and templates.
Don't miss our first part of the series, Get Your Equipment Leases Ready for FASB and IASB.
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