The Financial Accounting Standards Board on Nov. 20 released a report on the post-implementation review of its 2016 standard on leases, which says that while the standard achieved its overall objective, the initial costs to implement the lessee requirements along with the ongoing costs to apply those requirements “were significantly higher than the board expected at issuance.”
The primary objective of the leases standard (Topic 842) was to provide investors and other financial statement users with relevant information by requiring that lessees recognize lease assets and lease liabilities that arise from all leases on the balance sheet and to disclose key information about their lease transactions, the FASB states.
In addition, the leases standard sought to more closely align lessor requirements with the comparable guidance in Topic 606, Revenue from Contracts with Customers, and Topic 610, Other Income. The FASB was also asked by the Securities and Exchange Commission to reconsider and revise its previous lessee accounting guidance.
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“We recognize our stakeholders’ commitment to undertake a high-quality implementation of a major accounting standard and the level of effort necessary for stakeholders of varying sizes to undertake a significant accounting change,” FASB Chair Richard Jones and Technical Director Jackson Day wrote in the report. “While the Leases PIR process is complete, the FASB’s work supporting the application of the leases standard is not. We will continue to monitor and, if appropriate, make improvements to the standard.”
The PIR process is a quality control mechanism built into the FASB’s standard-setting process to evaluate whether a standard is achieving its objective by providing investors and other financial statement users with relevant information in ways that justify the cost of providing it.
The report discusses how FASB staff conducted the leases PIR process, which included outreach with more than 1,600 individuals from diverse backgrounds and implementation support provided throughout the adoption of the leases standard. Using what was learned during the PIR process, the report describes improvements that were made to the leases standard and, more broadly, areas of improvement for future standard-setting.
In general, the report says the leases standard achieved the objective of providing investors and other financial statement users with more useful information about a lessee’s leasing activities.
“Although feedback from investors on the usefulness of lessees recognizing lease assets and lease liabilities is mixed, for many investors the lease assets and lease liabilities are a useful starting point that improves comparability of leases across reporting entities,” the report says.
It adds that investors and other users of financial statements are generally satisfied with the information provided under the lessor accounting requirements.
The report cites many entities’ existing systems and processes initially not being able to account for operating leases on the balance sheet as a reason for the higher-than-anticipated costs to implement the lessee requirements. In addition, significant time and effort were expended to identify an entity’s lease arrangements and incorporate the lease terms into their accounting systems and processes, the report states.
A section of the report, “Costs,” points out:
- The implementation and ongoing costs to apply the standard are significantly greater than anticipated. There was a significant gap between stakeholder assertions received before the issuance of the leases standard that existing systems and processes were adequate to adopt Topic 842 and actual outcomes.
- Many entities needed additional resources to understand, initially implement, and apply Topic 842 on an ongoing basis. For example, many lessees comprehensively reviewed their existing contracts to identify a complete population of leases and incorporated the terms of those leases into accounting records.
- Stakeholders noted that more robust internal controls and processes had to be established to comply with Topic 842.
“Many preparers experienced significant costs to apply the leases standard initially and on an ongoing basis, most notably because their existing systems and processes were not equipped to account for all of their leases on the balance sheet,” the report states. “Additionally, preparers indicated that additional resources, such as additional staff and systems, were needed to apply aspects of the standard such as identifying leases, incorporating the terms of existing leases into the system, and determining the discount rate.
“The Board did not fully consider those costs during its deliberations in part because many preparers communicated that they expected to apply the new requirements using systems and processes similar to those used under legacy GAAP,” the report adds. “Many of the fundamental concepts in Topic 842 are similar to those in legacy GAAP, and entities needed information to apply those concepts to comply with previous disclosure requirements. Therefore, the Board expected that the level of effort to gather the information to apply the leases standard would not be significant. Instead, significant time and effort were expended to identify and validate the population of leases and lease provisions to incorporate into the accounting records and systems what was previously assembled for disclosure purposes outside of those records and systems.”
On the lessor side, the report says because many of the lessor accounting requirements were largely unchanged from legacy GAAP, most lessor entities “did not incur significant costs to either initially implement those requirements or apply the requirements on an ongoing basis.”
“After the issuance of the standard, the Board issued several Accounting Standards Updates to make lessor financial accounting outcomes more consistent with legacy GAAP,” the report states.
Upon concluding the leases PIR process, the report notes that FASB staff hasn’t identified any matters that warrant immediate standard-setting action on Topic 842. The staff will:
- Continue to support the application of Topic 842 primarily through the Technical Inquiry Service;
- Assess any need for targeted improvements to Topic 842 arising from stakeholder feedback, future agenda requests, or recommendations of the Private Company Council, the group that advises the FASB on private company accounting matters; and
- As part of the general standard-setting process, monitor for emerging practice issues or application issues related to the leases standard that should be considered by the board.
“In addition, the staff and the Board will continue to incorporate the feedback obtained from the Leases PIR process to improve future standard-setting activities,” the report says.
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