Proposed Standard (FASB)
Leases transactions are essential in every entity operating as a public or a private corporation. The Financial Accounting Standards Board (FASB)has issued frequent updates regarding leases, and its latest update (2018) highlighting essential recognition considerations that an entity should put in place to facilitate an elaborate and useful reporting to stakeholders. The standard regulating leases encompass two significant requirements: comparative reports since adoption and the separation of lease and nonlease components (for lessors). FASB requires entities to implement new lease standards systematically, whereby lessees must recognize lease assets notwithstanding those that may have expired before the effective date of the standard (Financial Accounting Standards Board, 2019). In addition, the stakeholders who include users of financial statements need detailed reports showing the separation of lease and nonlease items exclusively. In effect, an entity should account of lease components in accordance with the lease provisions given under the lease standard. Conversely, the accounting for nonlease items should follow the requirements stipulated by their respective standards (Financial Accounting Standards Board, 2019).
Fundamental Changes, Justification and Implications of the Update
The amendments stipulated in the lease standard (Topic 842) update affects all entities involved with lease contracts for comparative reporting at adoption. Updates relating to separating lease contracts’ components, on the other hand, affect only lessors whose contracts are practically expedient (Financial Accounting Standards Board, 2019). These amendments are applicable on or after the issuance of the update, that is October 01, 2018. Early adopters of the amendments may apply the new provisions provided by the update on or after January 01, 2018. Principal among the changes associated with the standard update are transition-comparative reporting at adoption and separating components of a contract.
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Transition-Comparative Reporting at Adoption
The new update provides entities involved with lease contracts with a convenient approach to adopting new leases standard. The transition method is optional, and entities can easily customize it to meet their precisions when accounting for leases. Under the new amendments, an organization initially employs the new standard at the adoption date and continuously make adjustments of retained earnings according to the preparers’ requests (Financial Accounting Standards Board, 2019). In effect, the comparative reports will still be consistent with the provisions stipulated by GAAP on leases. FASB requires an entity to disclose the adoption of the new transition method should it agree to adopt it. It is crucial to note that the amendments do not affect the provisions of Topic 840 on disclosure requirements. For instance, the update does not require preparation of interim disclosure statements that were not initially required.
Separating Components of a Contract
Lessors are required to disclose lease and nonlease components distinctively unless the two elements have the same timing and pattern of transfer, and accounting for the lease component would be considered as an operating lease. A user of financial statements such as the statement of financial position should be able to decipher the difference between lease and nonlease items. Further, the update recommends that accounting for the two elements should follow revenue provisions stipulated by Topic 606 if the nonlease component is the predominant component of the combines lease and nonlease item under recognition (Financial Accounting Standards Board, 2019). Key disclosers required by the new update include identification of the fact that it elected the desirable model and the class whose asset of the lessor was chosen. In addition, the update requires that an entity should disclose the nature of the lease or nonlease components combined and any nonlease items were not eligible to be combined. Lastly, an entity should disclose the Topic it applied in accounting for any combined element.
Analysis of the Proposed Standard
The FASB is constantly making amendments in the existing standards governing the recognition and disclosure of various financial items. Such changes encompass a documented strategy guideline on how and when changes in GAAP will be amended. The recent update on leases (Topic 842) expound the parameters and the basis that of recognition and disclosures of lease components. Further, the updates stipulate the guiding steps and provisions followed when accounting for non-lease items combined or substantively associated with lease items. Typically, FASB updates consist of implications with varying dimensions to both the preparers and users of financial information.
Advantages
One of the reasons making the 2018 FASB leases amendments easy to apply is that basic requirements of introductory provisions have not changed. For instance, it is unnecessary for an entity to reassess the existence of leases in existing or expired contracts. An organization willing to apply the amendments thus saves the costs of reassessment which is apparent in most other provisions (Harmon & Ntseh, 2016). Typical transitions of accounting standards require a significant re-evaluation of assets and items costs. In addition, the update does not require an entity to reassess direct costs associated with leases initially.
Users of financial information are also subjected to several benefits from the adoption and implementation of the lease amendments. Stakeholders vary with significance to the entity and the information they seek from financial reports. Usually, an entity determines the level of importance assigned to each of its various stakeholders depending on contribution to the ordinary revenue-generating activities. The update expands the paradigm of disclosure of lease components by requiring entities to report any changes made as per the requirements provided by update release. The provisions guiding the disclosure require a lessor to disclose the nature of the lease pertinent information as well as any information regarding the assumptions made when implementing the changes of the update (Harmon & Ntseh, 2016).
Limitations
While entities adopting the new leases standard update accrue various benefits, they are also prone to suffer some inconveniences arising from the amendments. Critical among them are the issues associated with inconsistency and failure to give comparable information. The FASB is not authoritative in the sense that the updates it provides on various accounting standards amendments are optional. Therefore, the mode of presenting information in financial statements may vary significantly and limit comparability of financial statements (Kim, Li, Lu & Yu, 2016). Information fails to be relevant and faithful if it is not comparable with similar information, which is paramount to users such as investors seeking to understand the critical elements differentiating an entity to another (Kim, Li, Lu & Yu, 2016).
Furthermore, the combined recognition of an item comprised of the lease and nonlease items fail to meet the objective of improving financial reporting explicitly. Reporting separate components conjointly minimize the availability of decision-useful information to users (Rodriguez, 2016). One of the given circumstances under which an entity may not recognize lease and nonlease components separately is when the time and pattern of transfer for the two are the same. However, some elements with the same time and design of transfer may have significantly different economic inflows. Reporting such items together will, therefore, limit the usefulness of financial information. This requirement also inhibits transparency of financial information by discouraging separation of lease items and ignoring the economic significance of such items (Rodriguez, 2016).
References
Financial Accounting Standards Board. (2019). Accounting Standards Update 2018-11— Leases (Topic 842): Targeted Improvements . (2019). Fasb.org . Retrieved 26 February 2019, from https://www.fasb.org/cs/ContentServer?c=Document_C&cid=1176170977888&d=&p agename=FASB%2FDocument_C%2FDocumentPage.
Harmon, F., & Ntseh, D. (2016). The New FASB & IASB Revenue Recognition Standards; Implementation and Effects.
Kim, J. B., Li, L., Lu, L. Y., & Yu, Y. (2016). Financial statement comparability and expected crash risk. Journal of Accounting and Economics , 61 (2-3), 294-312.
RackSpace Hosting, Inc. (2019). Sec.gov . Retrieved 26 February 2019, from https://www.sec.gov/cgi- bin/viewer?action=view&cik=1107694&accession_number=0001107694-16- 000092&xbrl_type=v#.
Rodriguez, R. (2016). Why the FASB s New Leasing Standard Falls Short of User Needs.
