The Impacts of Variable and Not-Yet-Commenced Leases
The Financial Accounting Standards Board (FASB) introduced ASU 2016-02 (Topic 842) to require companies to recognize operating lease assets and liabilities on the balance sheet. Details here. However, companies have found other ways to continue to hide lease debt from their balance sheets as detailed in Variable Leases Under ASC 842: First Evidence on Properties and Consequences. As a result, we’re updating our models to ensure they capture all liabilities related to operating leases, both on and off-balance sheet.
Background
As part of ASU 2016-02, companies can exclude variable lease payments from the initial recognition of the total operating lease obligation if certain criteria are met. Companies can classify a lease as variable if it is linked to an index or specific rate or based on a performance metric or output.
Lease payments based on a performance metric or output are excluded from the initial calculation of the total lease obligation. As the performance metrics are met, a company incurs variable lease costs in lieu of revaluing the total obligation.
Because companies can exclude these variable lease costs from the total operating lease obligation, they can materially reduce the amount of lease liabilities reported on the balance sheet. As a result, we updated our models to capture variable lease costs in our standardized present value of future operating leases calculation.
Additionally, ASU 2016-02 requires companies to provide information on leases that are signed and create significant rights or obligations for the lessee but have not yet commenced. These “Not-Yet -Commenced” leases are also excluded from the operating lease obligation, and we updated our models to capture them in our standardized present value of future operating leases calculation.
The Update: Including Variable and Not-Yet-Commenced Lease Expenses in Operating Leases