Challenges Related to the New Leases Standard

Management should focus on making sure the entity has controls in place to appropriately account for leases under the new leases standard. This will require companies to design different policies, processes and controls to account for leases prospectively (i.e., beginning in the quarter that the standard is adopted) because the prospective accounting model for the new leases standard is different from its transition provisions for existing leases (which, for most entities, will involve applying certain concepts of both Accounting Standards Codification (ASC) 840 and ASC 842). It may be challenging for entities to manage separate processes and controls over their entire lease portfolio — one for leases that existed at adoption and another for new leases and those that are modified or reassessed after adoption.

We believe processes and controls in place at the effective date may evolve throughout the year of adoption. For example, if a company implements a new system or modifies an existing one after the effective date, management will need to consider additional processes and controls necessary to address the risks resulting from those IT system changes.

Companies should remember that they will need to make judgments and estimates that will require careful consideration, including the determination of whether a contract is or contains a lease, the allocation of consideration between lease and non-lease components, the determination of the discount rate for the lease and identifying reassessment events.

Other judgments relate to evaluating asset groups for impairment under ASC 360, particularly now that lessees will record right-of-use (ROU) assets and lease liabilities for operating leases under the new leases standard. Consistent with how we evaluate impairment for capital leases under existing guidance, all asset groups that include ROU assets under ASC 842 are subject to impairment testing under ASC 360, which is the guidance used to test long-lived assets, such as property, plant and equipment, for impairment.

As a reminder, when a registrant adopts a new accounting standard in an interim period, the Securities and Exchange Commission (SEC) staff expects registrants to provide both the annual and the interim period financial statement disclosures in quarterly filings in the year of adoption. Preparers will need to provide more disclosures than under legacy guidance, including information about significant judgments and estimates made (for example, determination of discount rates), qualitative and quantitative information (for example, lease liability maturity analysis and terms on which variable lease payments are determined) and practical expedients elected (for example, combining lease and non-lease components). Companies should continually challenge their disclosures based on SEC staff observations and industry practice.

Separately, the Financial Accounting Standards Board (FASB or Board) added guidance to ASC 842 that is similar to the fair value exception in ASC 840-10-55-44 for lessors that are not manufacturers or dealers. The amendments also clarify that lessors in the scope of ASC 942 must classify principal payments received from sales-type and direct financing leases within investing activities in the statement of cash flows. In addition, the amendments clarify the transition guidance in ASC 842-10-65-1(i) related to interim disclosures provided in the year of adoption.
(Source: EY Financial Reporting Briefs - March 2019)