The updated lease accounting standard is currently in effect for private companies. After several postponements during the pandemic, the Financial Accounting Standards Board (FASB) voted unanimously to move forward with the changes. That means private companies and private not-for-profit entities that follow U.S. Generally Accepted Accounting Principles (GAAP) must adopt the new standard for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Surprisingly, some organizations still haven’t completed the implementation process, however. (Note: The updated accounting rules for long-term leases took effect for public companies in 2019.)
In a nutshell
Under the updated guidance, organizations must report both operating and finance leases on their balance sheets (with the exception of short-term leases with terms of 12 months or less). Previously, operating leases didn’t have to be recorded on the balance sheet.
This means lessees must now record a “right-to-use” asset and a corresponding liability for lease payments over the expected term. Generally, the asset and liability are based on the present value of minimum payments expected to be made under the lease, with certain adjustments. The updated guidance also requires additional disclosures about the amount, timing and uncertainty of cash flows related to leases.
How will these changes affect your organization’s financial statements? The effects vary, but if you have significant operating leases for buildings, equipment, vehicles, technology and other assets, adopting the updated standard will immediately increase your company’s assets and liabilities, making it appear to be more leveraged than before. This can cause technical violations of loan covenants that limit your debt or require you to maintain certain debt ratios. You might want to forewarn your lenders if you expect major changes to your year-end financial results under the updated guidance.
A major undertaking
Based on our experiences with public companies and other organizations that have already implemented the updated lease standard, the biggest challenge will be to locate all of your leases and extract the data necessary. Leases generally aren’t standardized, so reviewing them and gathering the required data — including lease terms, payment schedules, end-of-term options and incentives — can be a time-consuming, manual task.
Another challenge will be identifying leasing arrangements that must be accounted for under the updated standard but aren’t found in traditional lease agreements. If an agreement gives you the right to control an identified asset for a period of time in exchange for payment, then it may be considered a lease under the updated guidance. For example, leases may be “embedded” in service, supply, transportation or information technology agreements. With embedded leases, you’ll need to separate the contract’s lease and nonlease components for reporting purposes.
Leverage external resources
Organizations with significant leasing arrangements might want to consider purchasing lease accounting software to automate the process of managing and tracking their leases and calculating their lease-related assets and liabilities. If you haven’t yet started the implementation process, we can help you evaluate software options and get your accounting records and systems up to speed. Contact us for more information.
Information provided on this web site “Site” by Thompson Greenspon is intended for reference only. The information contained herein is designed solely to provide guidance to the user, and is not intended to be a substitute for the user seeking personalized professional advice based on specific factual situations. This Site may contain references to certain laws and regulations which may change over time and should be interpreted only in light of particular circumstances. As such, information on this Site does NOT constitute professional accounting, tax or legal advice and should not be interpreted as such.
Although Thompson Greenspon has made every reasonable effort to ensure that the information provided is accurate, Thompson Greenspon, and its shareholders, managers and staff, make no warranties, expressed or implied, on the information provided on this Site, or about any other website which you may access through this Site. The user accepts the information as is and assumes all responsibility for the use of such information. Thompson Greenspon also does not warrant that this Site, various services provided through this Site, and any information, software or other material downloaded from this Site, will be uninterrupted, error-free, omission-free or free of viruses or other harmful components.
Information contained on this Site is protected by copyright and may not be reproduced in any form without the expressed, written consent of Thompson Greenspon. All rights are reserved.
Ready to talk to one of our specialists?
Our specialists are all seasoned professionals who have years of experience working within your industry. Reach out to us today to schedule a consultation.