In 2016, the US federal government changed the accounting standards for lease agreements. These new standards, going into effect in 2020 and 2021, present several challenges for lessors. In order to keep their books in compliance with the new rules, lessors have to change several aspects of their recording process. To do this, they must first familiarize themselves with the new rules and processes. Here are the most prominent new lease accounting rules for lessors.
Initial & Subsequent Valuation
The new lease accounting rules have changed the requirements for initial and subsequent property valuations. Operating and finance leases now use the same accounting standards. Under the new standard, the future lease liability payments are a business credit with a corresponding debit in the right-of-use asset. This credit is decreased over time similar to how the principle of any other debt is reduced. While the principle behind the accounting practices are similar, lessors must keep these specific changes in mind while updating their practices.
New Classifications Of Leases
Under the new accounting rules there are two main classifications of leases, finance and operating leases. A finance lease is a contract that transfers the underlying asset to the lessee upon completion. The term of the contract must be for most of the remaining useful life of the underlying asset. Additionally, this category would only cover items that are specialized in nature and have few uses besides the one stated in the contract. An operating lease is simply anything that does not meet the qualifications of a finance lease. Surely, you must understand these new classification standards in order to comply with the new accounting rules.
Changes To Bookkeeping Standards
Lessors are required to update their bookkeeping methods to comply with the new laws regarding leases. Previously, certain leases were allowed to be loosely recorded in the overall business debts and credits portion of an asset sheet. Now, any lease with a term over 12 months must be recorded as such. For finance leases, lessors must record the amount of money they expect to make over the lifetime of the lease as a credit to accounts receivable. These changes to accounting standards means that many more items must be represented on the bookkeeping records.
New Right-Of-Use Standards
The right-of-use (ROU) standards for lessors have also been impacted by the new accounting rules in several key ways. Only contracts containing a proper ROU are leases. A customer must have the right to obtain all the monetary benefits from the use of the leased item. They must have independent oversight on the asset. Finally, they must have the right to operate the asset in any way they see fit. Under the new accounting rules, only contracts that meet these ROU standards are leases.
Contracts With Multiple Components
In some cases, lessors may create contracts with lease and non-lease components. In order to keep track of these contracts from an accounting perspective, certain steps must be taken. First, only the leased item’s value is counted. A non-lease component is any aspect of the contract that does not fit with the new ROU standards. The only exception is if the lessee specifically chooses to combine all non-lease items with the lease. In this case, all cash flow from the contract is counted as a lease. Lessors should update the way they record these complex contracts in order to comply with the new accounting standards.
The changes made to the existing accounting rules for leases present several challenges for lessors. Lessors must change their initial valuations of both financial and operating leases. The scope of certain lease classifications have radically changed as well. Bookkeeping business standards have been expanded to include any lease over $5000 and 12 months in length. New right-of-use standards have been introduced to redefine what types of contracts are considered leases. Any contracts that partially contain leases now only count the value of the leased asset when amortizing that lease. Lessors should understand these new rules well to update their practices to comply with the new accounting rules for leases.