The Modified Retrospective Approach in ASC 842: A Comprehensive Overview
The ASC 842 lease accounting standard, which supersedes ASC 840, introduces changes in how companies must recognize, measure, and report leases on their financial statements.
One key transition method to implement these new rules is the Modified Retrospective Approach. This option simplifies adoption and offers flexibility for businesses looking to comply without overhauling prior financial periods.
What is the Modified Retrospective Approach?
The Modified Retrospective Approach allows organizations to adopt ASC 842 by applying the new lease accounting guidance either as of the effective date or at the beginning of the earliest comparative period presented in financial statements.
This approach minimizes disruption and helps avoid restating prior financial data for earlier periods.
Key Options Under the Modified Retrospective Approach
1. Effective Date Method:
This option allows companies to apply ASC 842 as of the effective date (e.g., January 1, 2019, for public companies). By doing so, organizations recognize cumulative lease impacts on their balance sheets, and disclosures are made for leases that exist at the effective date.
This method avoids the need for restating prior periods, making it less complex to implement.
2. Comparative Method:
Under this option, companies apply ASC 842 retrospectively to all periods presented in the financial statements. This provides more comparability for financial data across periods but requires significant effort in revisiting past leases.
Companies choosing this method offer more clarity on historical lease data, but the added complexity can be a burden.
Practical Expedients to Ease Transition
ASC 842 also allows practical expedients for businesses, which further streamline adoption through the Modified Retrospective Approach. Some of these include:
No reassessment of lease classification: Companies can maintain existing lease classifications (operating or finance leases) from ASC 840.
Exclusion of initial direct costs: Organizations can elect to exclude initial direct costs that would have been incurred under ASC 840 when transitioning to ASC 842.
Grandfathering of certain leases: By utilizing practical expedients, businesses avoid revisiting embedded leases and lease contract terms for historical leases.
These practical expedients make transitioning under the Modified Retrospective Approach smoother, reducing administrative and compliance burdens.
Advantages of the Modified Retrospective Approach
1. Reduced Complexity: By avoiding the need to restate prior periods, the Effective Date Method is less complicated, helping companies achieve compliance with fewer disruptions.
2. Improved Comparability: The Comparative Method offers detailed historical data, making it easier to compare financials across periods, although this requires more effort.
3. Streamlined Transition: Practical expedients help reduce the administrative burden, making the transition process more efficient for businesses.
Challenges and Considerations
While the Modified Retrospective Approach eases the transition, businesses should carefully evaluate their lease portfolios and ensure accurate lease data capture.
The choice between the Effective Date and Comparative methods depends on the company's specific needs for comparability, complexity, and available resources.
Both options have benefits, but the decision will affect financial reporting and investor communications.
Conclusion
The Modified Retrospective Approach provides an efficient way for companies to comply with ASC 842 lease accounting without restating prior periods.
By offering flexibility and practical expedients, businesses can choose the level of complexity they are willing to manage.
Whether opting for the Effective Date or Comparative Method, this approach ensures smoother implementation of the new lease accounting standards while maintaining compliance.