New Lease Accounting — It’s Here, Are You Ready?

The new lease standard, Financial Accounting Standards Board (FASB) ASC 842, is effective for private companies with fiscal years beginning after December 15, 2021. Begin today to evaluate the technical accounting challenges and resources needed for implementation.

What’s changing?

Previously, complex rules required entities to distinguish between operating and capital leases. Now, under generally accepted accounting principles, the right to use leased property meets the definition of an asset, and the obligation to make lease payments represents a liability. As such, both should be recognized in the financial statements of a lessee.

The new leasing standard generally brings all leases onto the balance sheet. Further, both the quantitative and qualitative financial statement disclosure requirements have been significantly enhanced. This enables users of the financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.

It’s not only important for organizations to understand how this will change internal reporting, but also how their financial statements will be viewed by third parties, especially when seeking future financing. The implementation is quickly approaching — start designing and implementing accounting processes that meet the new requirements now.

Lease identification

Leases contracts are everywhere, whether you know it or not. A lease under ASC 842 can be a specific physical identifiable asset in a lease, or an identified asset embedded in an arrangement that appears to be a supply arrangement or service contract. Therefore, not all leases under ASC 842 will be called a lease. Reviewing and concluding on contracts with embedded leases can be time-consuming and require significant accounting knowledge and judgment.

Lease terms

Under the new accounting standard, the operating entity should report right-of-use assets and obligations based on legal enforceability of the contract term, including formal renewal options. The new standard also brings complexities and judgments.

• Without a written agreement, it is difficult to determine the legal enforceability of a lease.
• Verbal and written contracts with the potential for cancelation could have additional complexities.
• For short-term leases, a lessee can elect (by asset class) not to record on the balance sheet a lease whose “term” is 12 months or less and does not include a purchase option that the lessee is reasonably certain to exercise.
• If renewal options are reasonably certain to be exercised, they should be included in the lease term when determining the right-of-use asset and lease liability reported on the balance sheet.

Lease implementation

Finding the right accounting approach for leases will depend on how many you have and what type of information is needed to manage your organization. Although the implementation process can be timing-consuming and expensive, understanding your lease environment now can help prepare you for a successful transition.

• There are several simple tools and enterprise solutions available to help organizations meet their financial reporting needs under the new standard.
• More judgment may be needed when entering into new lease agreements, and companies may need to raise awareness throughout the organization.
• Procurement and approval processes may be impacted as companies evaluate lease versus buy decisions as the majority of leases are no longer off balance sheet.
• Debt covenant compliance may be impacted as a result of the new standard. Discuss potential impacts and any modifications to existing debt arrangements with your lender.

How we can help

CLA can help you take steps to stay ahead of the new lease accounting standards. We can help assess organizational impacts beyond general accounting and financial reporting, and walk you through readiness assessment, software selection and analysis, and implementation.