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While ASC 842 does not contain a specific exemption, an entity is not required to apply U.S. GAAP to immaterial items; therefore, materiality is always a consideration in the preparation of financial statements. However, an entity should not simply default to its existing capitalization threshold for PP&E for the following reasons:
- The existing capitalization threshold for PP&E is unlikely to include the effect of the additional asset base introduced by ASC 842. The addition of leased assets to the balance sheet may require a refreshed analysis of the entity’s capitalization thresholds to ensure that the aggregated amounts will not become material.
- The existing capitalization threshold for PP&E does not take into account the liability side of the balance sheet. Under ASC 842, if an entity wishes to establish a threshold that will be used to avoid accounting for both ROU assets and lease liabilities on the balance sheet, it must consider the materiality, in the aggregate, of all of its ROU assets and related lease liabilities that would be excluded when it adopts such a threshold.
One reasonable approach to developing a capitalization threshold for leases is to use the lesser of the following:
- A capitalization threshold for PP&E, including ROU assets
- A recognition threshold for liabilities that considers the effect of lease liabilities
When evaluating and applying a capitalization threshold for leases, entities should consider the following:
- The gross balance of each side of the lease entry — It would be inappropriate for an entity to consider only the net balance sheet effect of the lease entry (which is often zero) when assessing materiality.
- Disclosure requirements — Entities will often want to omit disclosures about leases that they have determined, on the basis of their use of capitalization thresholds (as discussed above), do not need to be recognized on the balance sheet. While it may be appropriate to omit such disclosures, an entity will need to consider the impact of the omitted disclosures when performing a materiality assessment to establish the thresholds.
- Implications related to internal control over financial reporting (ICFR) — As entities revisit and change (or create new) capitalization thresholds for financial reporting purposes, they should be cognizant of the related ICFR implications. In addition, entities should consider the Form 10-K and Form 10-Q disclosure requirements under SEC Regulation S-K, Item 308(c), with respect to material changes in ICFR.
- SAB Topic 1.M (SAB 99) — Entities may find the guidance on materiality in SAB Topic 1.M helpful when identifying an appropriate capitalization threshold for leases.
Accounting Guidance Referenced:
- Deloitte A Roadmap to Applying the New Leasing Standard (2020) Q&A 2-1
- ASU 2016-02