In today's business world, cases of off-balance-sheet dealings with regards to leasing have been a significant concern. According to Weidner (2016), the United States Securities and Exchange Commission published outcomes of an assessment carried out of lease accounting in 2005 report named “Report and Recommendations Pursuant to Section 401c of the Sarbanes-Oxley Act of 2002 on arrangements with off-balance-sheet implications, special purpose entities, and transparency of fillings by users.” Conclusions from the study stated that “approximately $ 1.25 trillion in non-cancellable future cash obligations committed under operating leases that are not recognized on issuer balance sheets but are instead disclosed in the notes in the financial statements” (Weidner, 2016).
From the study results, there was a need for modifications in the prevailing requirements for leasing. The goal for the amendments and recommendations was to enhance transparency and accountability in financial reporting with regards to the leasing operations of companies in order to assure investors and other stakeholders accuracy in the view of the impacts of lease responsibilities on the financial statements.
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The Financial Accounting Standard Board (FASB) give out the update ASU 2016-02 in 2016 in collaboration with the International Financial Accounting Standards (IASB). According to the update, all businesses were required to enter accounts for operating leases on financial statements. Before any amendment was done, companies included financial or capital leases on financial statements, but then operational leases were recorded in the notes section. The new ASU 2016-02 will require capital leases to be termed as finance leases. Additionally, all kinds of leases or contracts will be subjected to financial reporting. Joubert, Garvie, & Parle (2017) state that lease corporations will also be mandated to "recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payment, in the statement of financial position.” ASU 2016-02 requires the public companies to effect the changes as from the beginning of the first quarter in 2019, and other organizations will implement the same in the first quarter of 2020. The update responds to the investor’s requests regarding more transparency in accounting for lease activities.
Leases are essential in businesses and should be maintained well, more focus on the way they function, and individuals should ensure they keep a track on them by keeping up with them. It is crucial to observe lease operations in order to ensure effectiveness and accuracy in the way they are recorded. Organizations in the accounting industry, such as the FASB, possess an understanding and capability of how to record the necessary kind of information clients would want to access. Usually, this is the kind of duties performed upon the reporting of contracts “the FASB is issuing this update to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about lease arrangements” (Singer, Pfaff, Winiarski, & Winiarski, 2017).
Recording lease transactions is crucial to the stability and success of various specialized brands. If such recordings are not made accordingly, extensive and dedicated measures must follow to ensure the value of the organization’s bookkeeping activities are completed. “The prevalence of leasing, therefore, means that it is important that users of financial statements have a complete and understandable picture of an entity’s leasing activities” (Singer et al., 2017). Amendments such as ASU 2016-02, therefore, covers aspects like explained above. The amendment was set up to take into account the realistic representations of the duties and rights which could come up, as the lessees have to identify the lease liabilities and lease assets that are derived from leases within financial situations. The amendment of ASU also requires the disclosure of quantitative and qualitative information, whether there are cases of adjustable lease payments, renewal plans, or any termination plans put in place. Accounting for leases should be done according to the regulations of Generally Accepted Accounting Principles (GAAP). The updates made in ASU can assist in addressing any accuracies resulting from lease information and any problems arising in the recording of transactions made.
ASU 2016-02 utilizes the operating lease using its methods of processing for the reason that it aids in keeping the liabilities and assets off financial statements, and liabilities will be noted in footnotes (Hseih & Su, 2015). On the other hand, capital leasing necessitates liabilities and assets to be added in financial statements.
The update ASU 2016-02 is intended to be applied in kind of leases, which entails the scope of changes in accounting standards, which is referred to as Topic 842. In order to develop a realistic idea of how the concept of Topic 842 is used in accounting for leases, we will use Starbucks as an example. Three elements should be looked into when attempting to comprehend the association between an organization and leases. One of the elements Starbucks emphases is referred to as contingent rent. The idea of contingent rent refers to lease payments, which do not take into account a fixed amount. The payments fluctuate as a result of price indices, future sales, an increase in market rates, and future use. Although this element may be predictable, it requires extreme expertise, preparations, and talent for it to be effective and successful.
Contingent rent may also be based on either inflation or deflation, which relates to incline and decline in productivity. Contingent Rental Agreement is interconnected with the financial situation of the lessee, price fluctuations, and the leased assets of the lessee. As outlined in the Starbucks website, “Starbucks records a contingent rent liability in accrued occupancy costs within accrued liabilities on the consolidated balance sheets and the corresponding rent expense when Starbucks determines that achieving the specified levels during the fiscal year is presumable" ("Starbucks Corp. (SBUX) | Operating Leases," 2015). Starbucks is a successful business and accounts for any future profits and sales turnovers, which makes this element essential for the business. Another element used by Starbucks in reporting is the minimum rent. According to Wilkins (2015), the element is described as “the payments that the lessee is obligated to make or can be required to make in connection with leased property.” Starbucks records various expenses of minimum rent using the straight-line technique when the rent starts in a different date other than the initial period. In the rent accrued account, adjustments will be made accordingly, which would, in turn, would be reflected during financial reporting.
Rent liability is the final element used by Starbucks to account for leases. According to research, “for tenant improvement allowances and rent holidays, Starbucks records a deferred rent liability within accrued rent liabilities, or other long-term liabilities on the consolidated balance sheet and amortizes the deferred rent over the terms of the leases as reductions to rent expense in cost of sales including occupancy costs on the consolidated statement of earnings” (Stock Analysis on Net 2015).
Various elements that have been discussed above are essential components that the Starbucks company uses in accounting for leases under the amendments set out in the ASU 2016-02, which allows for improved, outstanding, and accurate records for company leases. Specific signs may be determined for the purpose of addressing any adjustments made as a result of the amendments. According to the Flower & Ebbers (2018), “Topic 842 requires an entity to separate the lease components from the non-lease components in a contract. Although this was a requirement in the previous GAAP, Topic 842 provides more guidance on how to identify and separate components than previous GAAP.” This aspect is vital in accounting as more directives presented by Topic 842 allows for enhanced results from the professionals dealing with leasing transactions.
The lessee may express some accounting policies which call for the non-separation of the lease as well as the non-lease elements. The lessee’s decision would require non-lease elements to be recorded with lease components, which in turn establishes a single lease element. Maintaining lease transactions for a company like Starbucks appears to be an in-depth concept that requires a lot of information and details. Still, through the application of the right policies and procedures, the process can be achieved effectively and successfully.
Stock analysis may be perfect examples of companies that could utilize the idea of Topic 842, and it is essential to possess the capacity to look into various ways of executing their rules from the initial point. ASU 2016-02 updates may utilize ratio analysis methodology to assess the well-being of the business. For instance, Starbucks has various ratios that the ASU 2016-02 amendment aid to express. The ratios include debt-to-equity, derived by dividing the adjusted value of debt with the total shareholder's fund. The ratio has been declining for Starbucks over the last five years. ASU 2016-02 is useful in enabling other organizations to obtain the information of the company, and thus assist in eliminating concerns which could lead to possible insolvency or winding up of the company ("Starbucks Corp. (SBUX) | Operating Leases," 2015). Other ratios that could be relevant to Starbucks are the Return on Assets (ROA) and the interest coverage ratio, which have been declining too over the years.
In conclusion, the ASU 2016-02 brings simplicity to the formerly biased financial statements, which were set out in the previous guidelines for lease accounting. New guidelines from the update require privates and public companies to record lease in the annual financial statements. The standard will heighten the comparability plus understanding of the financial accounts of the lessee, and also simplifies lease definition to address practical concerns in the present GAAP. In addition, it also aligns the idea of control, which is used in the description, closer to the control principle applied in recognition of revenues and consolidations. The illustrations used in this paper assists corporations in avoiding the possibility of falling for negative aspects, which could lead to business failure. Different scenarios discussed will assist companies in ensuring they are on top of any issues and develop more efficient strategies of accounting practice. Accounting knowledge would aid in implementing any lease adjustments and changes necessary to achieve better outcomes.
References
Flower, J., & Ebbers, G. (2018). Global financial reporting . Macmillan International Higher Education. P. 56.
Hsieh, S. J., & Su, Y. (2015). The economic implications of the earnings impact from lease capitalization. Advances in Accounting , 31 (1), 42-54.
Joubert, M., Garvie, L., & Parle, G. (2017). Implications of the New Accounting Standard for Leases AASB 16 (IFRS 16) with the Inclusion of Operating Leases in the Balance Sheet. The Journal of New Business Ideas & Trends , 15 (2), 1-11.
Singer, R., Pfaff, A., Winiarski, H., & Winiarski, M. (2017). Accounting for Leases Under the New Standard, Part 1: Definition and Classification of Leases and Lessee Accounting. The CPA Journal , 87 (8), 44-51.
Starbucks Corp. (SBUX) | Operating Leases. (2015). Retrieved from https://www.stock-analysis-on.net/NASDAQ/Company/Starbucks-Corp/Analysis/Operating-Leases
Weidner, D. J. (2016). New FASB rules on accounting for leases: a Sarbanes-Oxley promise delivered.
Wilkins, T. A. (2015). Accounting for Leases Standards. Wiley Encyclopedia of Management , 1-4.
