Chapter 15 Discussion: Lease Accounting Standard Has Been Dr

Chapter 15 Discussionlease Accounting Standard Has Been Dramatical

Chapter 15 Discussion: Lease accounting standard has been dramatically revised in recent years. The entities that play a role of a lessee have seen their price decline, mainly due to the recently effective FASB ASC 842. Read Chap 15 Lease-Accounting Rules May Have Hurt Companies’ Valuations, Study Says - WSJ.pdf from WSJ and answer the following questions: · What authoritative requirements made “a recent change in how companies are expected to account for and report operating leases on company balance sheets”? · What are operating leases? How are they shown on corporate balance sheets? Describe measuring an amount to be included on the balance sheet and the accounts that are affected. · Consider your answer to the question above. How is it possible that accounting prior to the new lease accounting standard might not show leases on the balance sheet?

Paper For Above instruction

The recent overhaul of lease accounting standards, particularly the implementation of FASB ASC 842, represents a significant shift in how corporations report lease obligations on their financial statements. Historically, operating leases were kept off-balance sheet, leading to potential undervaluation of a company's liabilities and assets. The authoritative requirement behind this change comes from the Financial Accounting Standards Board (FASB), which issued ASC 842 to improve transparency and comparability among financial statements. This standard mandates that lessees recognize nearly all leases as lease assets and lease liabilities on the balance sheet, reflecting the true economic obligation of the company.

Operating leases, traditionally distinguished from capital or finance leases, are agreements where the lessee rents an asset, like property or equipment, for a period less than the asset's useful life, without transferring ownership rights. Under previous standards, operating leases did not appear on the company's balance sheet; instead, lease expenses were recognized on a straight-line basis in the income statement. With ASC 842, lessees now record a right-of-use (ROU) asset and a corresponding lease liability at the commencement date of the lease. The lease liability represents the present value of expected lease payments, calculated using an appropriate discount rate, typically the company's incremental borrowing rate or the rate implicit in the lease if available.

The measurement process involves identifying all fixed lease payments, including contingent rents, subleases, and renewal options reasonably certain to be exercised, then discounting these payments to determine the present value. This amount becomes the lease liability, and the same amount is recorded as a right-of-use asset—an intangible asset reflecting the company's right to use the leased asset during the lease term. The accounts affected include lease liabilities (a liability account) and right-of-use assets (an asset account). Additionally, depreciation expense on ROU assets and interest expense on lease liabilities are recognized over the lease term, affecting subsequent income statements.

Before ASC 842, accounting standards such as ASC 840 allowed lessees to classify operating leases as off-balance sheet commitments. These leases were merely disclosed in footnotes, with no recognition of the lease liabilities or right-of-use assets on the balance sheet. This discrepancy meant that companies could potentially inflate their asset base and underestimate liabilities, affecting key financial ratios, such as debt-to-assets or return on assets. The rationale for this treatment was based on the nature of operating leases as short-term, operational arrangements, and historically, the focus was on matching rent expenses to periods rather than recognizing long-term obligations.

References

• Financial Accounting Standards Board (FASB). (2016). ASC 842 Leases. Retrieved from https://asc.fasb.org/
• PricewaterhouseCoopers. (2020). Implementation Guide for ASC 842. PwC Publications.
• KPMG. (2019). Understanding the new lease accounting standard. KPMG Insights.
• Ernst & Young. (2021). ASC 842 education series. EY Publications.
• Wall Street Journal. (2021). Lease accounting rules may have hurt companies’ valuations. WSJ.
• Mobley, P. (2020). Lease accounting under ASC 842: A practical guide. Journal of Accountancy.
• Berliner, M.J. (2020). Lease capitalization and financial ratios: A review. Accounting Horizons.
• Deloitte. (2022). Leases: Transition to ASC 842. Deloitte Insights.
• Harvard Business Review. (2020). The impact of lease accounting on corporate valuations. HBR.
• International Accounting Standards Board (IASB). (2019). IFRS 16 Leases. IASB Publications.