Operating leases now live on the balance sheet, not footnotes

The record

On 25 February 2016 the Financial Accounting Standards Board issued Accounting Standards Update No. 2016-02, codified as Topic 842, Leases. FASB's own account, FASB In Focus, states that the update requires lessees to recognize a right-of-use asset and a lease liability on the balance sheet for leases with terms of more than twelve months, ending the prior treatment under which an operating lease, such as ten years of office space, appeared only in footnote disclosure. The document cites a 2005 SEC estimate that operating lease commitments off the balance sheet for SEC registrants then totaled 1.25 trillion dollars, the figure FASB gives as the scale of the disclosure gap the update was meant to close.

What the documents establish

The update does not treat every lease alike. FASB In Focus and the amendment text itself, Accounting Standards Update No. 2016-02, both describe two lessee classifications carried forward from prior practice, finance leases and operating leases, and both now appear on the balance sheet as a right-of-use asset and liability. What differs between them is the income statement and cash flow treatment: a finance lease produces separate amortization and interest expense, while an operating lease produces a single straight-line lease expense. Lessor accounting, the documents state, remains largely unchanged from prior GAAP. Effective dates also differ by filer type: fiscal years beginning after 15 December 2018 for public companies, and, per the 2020 revision described in the same In Focus summary, fiscal years beginning after 15 December 2021 for other organizations that had not yet issued financial statements as of 3 June 2020.

The operating read

As an editorial matter, a founder reviewing a lease-heavy company's balance sheet, retail, hospitality or lab space users especially, should expect a right-of-use asset and matching liability even for space the company merely rents rather than owns, and should not assume every lease-classification label maps to how the lease is described commercially. A lease called an operating lease in a term sheet is still on the balance sheet under Topic 842; what changes is only which income-statement line records its cost. Comparing a company's leverage or asset base before and after its Topic 842 transition without adjusting for this shift risks a false read on balance-sheet trends.

What to check before you decide

Before comparing lease-related figures across periods or companies, check the following against the filed financial statements and your own advisers:

• Which effective date applied to this entity, and did the transition create a one-time jump in reported assets and liabilities that predates any change in the company's actual leasing activity?
• Is each material lease classified as finance or operating, and does that classification match how its expense is presented on the income statement?
• Did the company elect any of the modified retrospective transition's practical expedients, and how does that affect comparability with an earlier period?

Topic 842 moved leasing obligations onto the balance sheet; it did not make every lease economically identical, and the finance-versus-operating distinction still carries real reporting consequences.