By Stephen LaBarbera, CPA – Manager, Doeren Mayhew

Simply put, many operating leases are going to be recorded on the balance sheet. Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842) is approaching its effective date in year 2020 for non-public entities. This ASU will replace the current lease accounting standard, Topic 840, and essentially transition lessee accounting for operating leases from “off balance sheet” to “on balance sheet” for nearly all leases with terms greater than one year.

For credit unions and community banks with operating leases, this ASU will require new accounting procedures, monitoring controls and reporting requirements, and may significantly increase total assets and liabilities at some institutions. In addition, management teams may need to reconsider how lease agreements are drafted to minimize certain accounting ramifications.

The Financial Accounting Standards Board did well to maintain much of the guidance from the current lease accounting standard, including guidance surrounding lessor accounting and lessee accounting for finance leases (formerly referred to as capital leases). Highlighted below is guidance that may impact your financial institution.

 Impactful ASU Highlights – Lessee Accounting

Operating lease: For operating leases, the lease liability is recorded at the present value (PV) of lease payments, the right-of-use (ROU) asset is recorded equal to the lease liability (subject to adjustments for prepaid/or accrued rent) and a “lease expense” is recorded to the income statement on a straight-line basis over the lease term. By design, the ASU did not impact how lease expense is recognized in the statement of income.

Optional periods:  Whether or not to include certain optional periods when calculating the lease liability will be an important estimate that may be material to the financial statements.

The ASU defines, “reasonably certain” as the threshold for assessing whether or not optional periods should be used to measure the lease liability. This determination is made in consideration of all relevant factors, such as leasehold improvements with significant value, the uniqueness of a property, its operating efficiency and other contract related cost (termination fees and variable payments).

Although reasonably certain is a high threshold, lease locations operating successfully that include significant leasehold improvements, may be considered reasonably certain to exercise options, especially options in the short-term future.

Presentation:  The ROU asset may be maintained as a component of other assets or presented as a separate line item on the statement of financial condition.  The lease liability may be maintained as a component of “Other Liabilities” or presented as a separate line item in the statement of financial condition.

Disclosures:  Qualitative and quantitative financial statement disclosure requirements have been expanded, therefore, in the year of implementation, preparing these disclosures may require a time commitment, specifically for credit unions and community banks with a significant number of leases.

Implementation:  A retrospective approach or modified retrospective approach will be used for the transition to the ASU.  This means when the guidance becomes effective, it will be effective for all periods presented in a comparative financial statement presentation. The modified retrospective approach includes some optional “practical expedients” that help with implementation.

Insightful Implementation Guidance

Although Topic 842 may not be considered to have a significant impact on the financial institution industry as a whole, it may have a significant impact on your credit union or community bank. A great way to understand how the ASU may affect your institution is by beginning the implementation process or by preparing lease amortization schedules. These schedules will provide key data, such as the restatement in the year of implementation, giving management useful information to help plan ahead and share with the board of directors.

When implementing the guidance under Topic 842, it is important credit unions and community banks closely review their lease arrangements’ specific facts and circumstances with the provisions in the ASU. Specific implementation questions should be discussed with a credit union CPA or bank CPA, like those at Doeren Mayhew.

To help with the implementation process, Doeren Mayhew’s Financial Institutions Group has made available a Lease Accounting Quick Guide for Financial Institutions, which provides more specific accounting guidance, and illustrates an amortization schedule and the related journal entries. Download it now!

If your financial institution is to ready begin the implementation process, rely on one of Doeren Mayhew’s qualified credit union CPAs or bank CPAs as a resource to your accounting group.  Reach out to them today at 888.433.4839.

Want to get in touch with the author? Email Stephen LaBarbera or contact him at 704.341.0970.