The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) took into consideration the magnitude of the task that would be implemented by the companies that would be implementing ASC 842 and IFRS 16 practical expedient during the development, review, codification, and final adoption of the standards. To alleviate some of the effects that the implementation of ASC 842 and IFRS 16 would have on companies, they added several workarounds or considerations known as practical expedient. We will discuss many of those useful workarounds in this article.
What is Practical Expedient?
A practical expedient is an accounting policy election allowed by the Financial Accounting Standards Board (FASB) that releases financial statement preparers from the obligation to comply with an accounting standard’s requirements.
ASC 842 offers practical expedients for organizations to streamline the adoption of the new lease accounting standard. When implementing the new standard initially, some workable solutions offer relief, while others make continuous compliance easier.
Useful Practical Expedients and Potential Traps
Possible Obstacles of Practical Expedients
To begin, allow us to define a “trap.” A “trap” occurs when an expedient is chosen to reduce the work required to adopt a standard, but instead shifts the burden to another location.
By using certain shortcuts, reporting on a company’s leasing portfolio may entail less work. If, on the other hand, a company’s expediency prevented it from listing each lease’s Present Value (PV) as a Right-of-Use Asset (ROU) and Lease Liability (LL) on its balance sheet, that does not preclude the company from reporting on the leases that benefited from the expediency.
To be more precise, it indicates that the financial statements’ footnotes need to be strengthened and extended to address and notify the recipient of the financial statements of the company about the advantage of choosing the aforementioned expedient(s).
Exemption for Short-Term Leases
Both the FASB and the IASB have approved the short-term lease exemption expedient, which permits a company to categorize a lease as short-term if it is for 12 months or less and exclude it from its balance sheet. Alternatively, a company may keep handling them like operating leases.
The IASB’s rule prohibits short-term leases with purchase options, regardless of lease length, unlike the FASB’s rule.
Conversely, the FASB’s acceptance of their expedient for short-term leases allowed for greater latitude. A lease with a purchase option that lasted 12 months or less may still be considered short-term as long as the lessee was reasonably assured that the option would not be exercised.
This Short-Term Lease Exemption is similar to the previously discussed “Trap” expedients in that, although it theoretically won’t be on your balance sheet, it still needs to be included in the notes.
Low-Value Asset Exclusion
The Low-Value Asset Exemption is a similarly useful workaround that, regrettably, was only accepted by the IASB. If a company uses this expedient and its lease assets have a new value of less than $5,000, it can avoid listing such assets on its balance sheet.
This case requires leasing scenarios for one asset at a sub-$5,000 value and 1,000 assets at a sub-$5,000 value.
The “Trap” expedient requires inclusion in footnotes, even if it won’t be on the balance sheet.
Practical Expedients Under ASC 842
The previously described methods are personal and can be used in that manner. Regardless of whether a company is a lessor or a lessee, there is a set of useful expedients available under the FASB adoption guidelines of ASC 842 that must be adopted jointly and implemented.
The package includes three expedients that can significantly save time when starting an ASC 842 project.
The first convenience is that the existence of leases in contracts does not need to be reevaluated. Organizations are assumed to already be correctly accounting for leases by ASC 840. They are therefore exempt from performing this reevaluation. This directly addresses the topic of embedded leases.
Organizations are spared from having to reevaluate whether the lease qualifies as a capital lease or an operating lease under ASC 840 thanks to the second expedient. ASC 842 now identifies operating leases or financing leases as the new term for capital leases.
Reevaluating the Initial Direct Costs in current leases is the third and last practical expedient in this bundle. Under ASC 840, a company could classify the internal expenses of obtaining a lease as Initial Direct Costs. ASC 842 defines direct costs as expenses that would not have been incurred if a lease had not been obtained.
ASC 842, a practical expedient, eliminates the need to reevaluate current lease(s) or Initial Direct Costs upon its implementation.
Practical Expedient: FAQs
What does the term “practical expedient” mean?
An accounting policy election that the Financial Accounting Standards Board (FASB) permits that relieves financial statement preparers of the difficulty of applying an accounting standard’s requirements is known as a practical expedient.
Which rule applies in practical expediency?
A practical expedient is a workaround introduced to the lease accounting standard to facilitate the adoption of a new standard. It is a useful use of a rule exception that facilitates the quicker switch to the new lease accounting standard.
What is a practical expedient in a portfolio?
When contracts have identical terms and the entity reasonably anticipates that applying the portfolio approach won’t materially differ from utilizing the contract method, then the portfolio method can be utilized as a practical expedient to recognize revenue.
What is the practical expedient for IFRS 16?
Lessees can consolidate lease and non-lease components into a single lease component, rather than dividing them based on asset class.
Practical Expedient: Conclusion
Significant issues with the new lease accounting standard and financial reporting led to the creation of workable workarounds. Utilizing shortcuts can save companies money and effort, but improper use can lead to accounting issues and cash flow disruptions.
