Question

We have a couple of leases, one that we record as a liability and one that we do not. How will this new lease requirement impact us? They also talked about adopting early. I may be interested in early adoption. What would we need to do to implement this change this year?

Upon investigation of Victory's records, you found that Victory had had two leases. One that is currently being accounted for as a capital lease and one being treated as an operating lease (under current standards).

The capital lease was for equipment. The lease started in 2016 and was a 5-year lease of annual lease payments of $50,000, starting on January 1, 2016. The lease also had a bargain purchase option for $20,000 at the end of the lease. The equipment had a useful life of 6 years and Victory uses the straight-line method of depreciation. The implicit interest rate for this lease was 6%.

The operating lease was a 15-year lease for their facilities that started on January 1, 2015. The lease consisted of annual rental payments, starting on January 1, 2015, of $60,000. When they started the lease in 2015, the expected useful life of the facility was 30 years. Victory imputed interest rate is 8%.

1. Assuming adoption in 2018, what journal entries will need to be made in 2018 for the transition to the new lease standard?

Answer 1

Don is talking about the FASB’s lease accounting standard change, ASU 2016-02, Leases (Topic 842), presents dramatic changes to the balance sheets of lessees. Under the new standard, lessor accounting is fundamentally consistent with existing GAAP.

The financing lease was shown on the balance sheet where the operating lease was shown in the income statement (off balance sheet). There won’t be much of a difference relating to the financing lease and it will continue to be reported to reported in the same manner. For the operating lease- the lessee will recognize lease liabilities based on the present value of remaining lease payments and corresponding lease assets for operating leases with some exception. The transition is modified retrospective. Hence there will be a transition period to incorporate these changes.

The company will record the lease of the facility on their balance sheet. The value of liability will be equal to present lease of liability. In this case PV(8%,12,-60000)= $452,164.68 for 2018 and PV(8%,13,-60000)= $474,226.56 for 2017. The value of lease asset will match that of liability in the initial period. This will inflate both assets and liabilities of the company. The lease asset should be tested for impairment periodically and the effect should be realized on the balance sheet. Lease expense will be shown as a single line item in operating expense.

The new lease standard will have a modified retrospective transition. So the company must apply the changes at the beginning of the earliest period presented in the financial statements. Meaning- for preparing financial statements in 2019 (for FY 2018), 2017 data is needs to be restated public companies. The balance sheet asset and liability is measured using the interest rate as of the date of earliest application i.e. 8%