In 2016, The Financial Accounting Standards Board (FASB) issued a major change to the accounting rules for leases. The new rules and regulations for leases will go into effect for nonpublic companies starting after December 31, 2019. Before the new standards go into effect next year, it is important to review the new rules so that companies can be well prepared for the changes in accounting.
Under the old GAAP rules, there are two classifications of leases: capital and operating leases. With a capital lease, the company which leases an asset records an asset and a liability representing the present value of future minimum lease payments on the books, and records interest and depreciation expense for the asset in addition to recording the payments on the lease. With an operating lease, the lessee only records a lease expense representing the payments on the lease, with no asset or liability recorded.
Under the new GAAP rules, the rules for capital leases have not changed. The major change is to the accounting for operating leases.
With the new rules, a company will have to record an asset and a liability representing future minimum lease payments for operating leases with a period of greater than 12 months. If a company’s operating lease has a period of 12 months or less, the company does not have to record the asset and liability. A company with an operating lease will not record interest or depreciation expense. This change was in order to better represent a company’s assets and obligations with respect to leases, and to bring the accounting in line for all leases.
In order to prepare for the changes, all companies should review their leases. If a company has only capital leases or operating leases with a period of 12 months or less, no accounting changes will be necessary for the coming year. If a company has an operating lease with a period of greater than 12 months, the company should determine the present value of future minimum payments in order to record the asset and liability under the new standards.