The new leases standard’s transition provisions are unique and complex. You can choose to apply the transition provisions at the beginning of the earliest comparative period presented in your financial statements or you can apply them at the date of adoption (i.e., the effective date). The latter option effectively allows you to continue to apply the guidance in ASC 840, including its disclosure requirements, in the comparative periods and may make the transition accounting easier to apply because you would not need to recast numbers for periods before adoption.
Regardless of when you apply the transition provisions, you’ll likely apply concepts from both ASC 840 and ASC 842 to leases that existed before the effective date. As a result, you’ll need to develop two sets of policies — one to calculate your transition adjustments and to continue to account for leases that commenced before the effective date, and another to account for new or modified leases on or after the effective date.
To reduce the amount of time you will spend reevaluating your leases, you can elect a package of transition practical expedients. Among other things, this package of practical expedients allows you not to reassess whether contracts that commenced before the effective date are leases or how those leases are classified. We expect most companies to apply this package of expedients.
You can also make several other policy elections in transition that can simplify the application of the new leases standard. For example, private companies that are lessees are permitted to make an accounting policy election to use a risk-free rate for the initial and subsequent measurement of lease liabilities and right-of-use assets.
While using a risk-free rate might reduce complexity, you should keep in mind that using a risk-free rate would increase the likelihood of a lease being classified as a finance lease and increase the initial measurement of the lease liability and right-of-use asset. In addition, if you’re considering going public, you may not want to make this election because you would have to retrospectively apply the public entity accounting and reporting requirements to all prior periods presented when you become a public company, and this would mean going back and estimating the discount rate.
Lessors and lessees can also simplify their accounting by making an accounting policy election to not separate their lease and associated non-lease components. Lessors must meet certain criteria to apply this election.