New Lease Accounting Standards – Part 2

As discussed in the previous blog, New Lease Accounting Standards Part 1, the Federal Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-02, Leases (Topic 842) on February 25, 2016. The update maintains two classifications of a lease, finance leases (which replaces capital leases), and operating leases.

The lessee should classify a lease as a finance lease if any of the following criteria are met at the time the lease is made:

• the lease transfers ownership of the underlying asset to the lessee by the end of the lease term;

• the lease grants the lessee an option to purchase the underlying asset that the lessee is “reasonably certain” to exercise;

• the lease term is for the major part of the remaining economic life of the underlying asset;

• the present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset; or

• the underlying asset is of such specialized nature that there is no expected alternative use to the lessor at the end of the lease term.

If none of these criteria are met, it is to be classified as an operating lease.

In the next blog, we will take a look at the reporting requirements for these two types of leases under the new Update. In the meantime, if you have any questions, please contact the Center for Financial, Legal, and Tax Planning, Inc.