In February of 2016 the Financial Accounting Standards Board (FASB) issued its new standard on accounting for leases ASU 2016-02, Leases (Topic 842).
The new standard, which is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, for any of the following:
1. A public business entity
2. A not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
3. An employee benefit plan that files financial statements with the U.S. Securities and Exchange Commission.
For all other entities, the standard is effective for fiscal years beginning after December 19, 2019, and interim periods within fiscal years beginning after December 15, 2020.
Why was this Lease Standard amended?
The FASB and the International Accounting Standard Board (IASB), had been working on this project for nearly a decade. The IASB issued its new lease standard in January 2016. The purpose of the new standard is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.
Who is Affected by Topic 842?
The new standard affects any entity that enters into a lease. The new standard defines a lease as a “contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.”
At the commencement of the lease, the lessee would recognize a liability for its lease obligation (initially measured at the present value of the future lease payments not yet paid over the lease term. In addition, the lessee would also recognize an asset for its right to use the asset (the right-of-use asset) equal to the lease liability, adjusted for lease payments made at or before lease commencement, lease incentives, and any direct initial costs. The lessee would use the effective interest rate method to subsequently account for the lease liability.
Potential Impact on Broker-Dealers
The recording of the right of use asset and a lease liability would have negatively impacted Broker-Dealers. Specifically, it would have impacted the Computation of Net Capital and Aggregate Indebtedness, if material, to the extent of broker-dealers falling out of compliance or needing an immediate capital infusion.
No Enforcement Action by the SEC
Fortunately, in a no-action letter, the SEC has provided broker-dealers with relief as follows:
“the Division will not recommend enforcement action to the Commission under Exchange Act Rule 1 Sc3-1 if a broker dealer computing net capital adds back an operating lease asset to the extent of the associated operating lease liability. If the value of the operating lease liability exceeds the value of the associated operating lease asset, the amount by which the liability’s value exceeds the associated lease asset must be deducted for net capital purposes. A broker-dealer cannot add back an operating lease asset to offset an operating lease liability unless the asset and the liability arise from the same operating lease; nor can a broker-dealer add back combined or aggregated operating lease assets to offset combined or aggregated operating lease liabilities.”
Further, “the Division will not recommend enforcement action to the Commission under Exchange Act Rule 15c3-1 if a broker-dealer determining its minimum capital requirement using the Al standard does not include in aggregate indebtedness an operating lease liability to the extent of the associated operating lease asset. If the value of the operating lease liability exceeds the associated operating lease asset, the amount by which the lease liability exceeds the lease asset must be included in the broker-dealer’s aggregate indebtedness. A broker-dealer cannot add back an operating lease asset to offset an operating lease liability unless the asset and the liability arise from the same operating lease, nor can a broker-dealer add back combined or aggregated operating lease assets to offset combined or aggregated operating lease activities.”
To learn more about the new lease accounting standard and how it may impact your organization, please contact your DeMarco Sciaccotta Wilkens & Dunleavy representative.