Don’t wait to implement the new lease accounting standard
This blog post was originally published on September 12, 2019. It was updated on August 1, 2022.
The new FASB lease accounting standard (ASC 842) may seem relatively straightforward, but it could be challenging to implement and may require substantial balance sheet changes.
The new lease accounting standard by the Financial Accounting Standards Board (FASB) is requiring companies to make substantial adjustments to how they report lease obligations and rights. Although the FASB delayed implementation, which provided certain entities with extra time, the effective date is now imminent, and you should not delay preparation.
The new standard could have a significant effect on your company’s balance sheet: Commitments that were previously disclosed in financial statements will instead appear as a lease liability on the balance sheet, with a corresponding right-of-use asset. This balance sheet recognition requirement applies to both finance and operating leases; however, it does not apply to leases shorter than one year. Furthermore, consideration of debt covenants is also imperative as the recordation of the lease liability may negatively impact compliance with certain covenants.
The new lease accounting standard also requires quantitative and qualitative disclosures about the amount, timing and uncertainty of cash flows arising from leases.
The FASB says the new lease accounting standard aims to increase financial transparency by providing a clearer picture of a company’s financial position to creditors, investors and others who use financial statements for decision making.
Timing of implementation
For certain entities, the new lease accounting standard went into effect for all interim financial reporting periods that began after December 15, 2018. That applies to public companies, non-profits that issue or have obligations related to traded securities, and employee benefit plans that furnish statements to the U.S. Securities and Exchange Commission.
The standard is set to go into effect for certain non-public entities, smaller firms and non-profits for annual periods beginning after December 15, 2021, and for interim periods within fiscal years beginning after December 15, 2022.
Don’t underestimate the impact
While the implications of the new accounting standard such as recording leases on the balance sheet may be fairly simple to understand, it can be challenging to put into practice. The trickiest part is often accounting for your organization’s entire population of leases. That can be a daunting task, depending on the number of agreements your company enters into. In other words, companies now need to be mindful of any leases that may be embedded in other agreements. Additionally, among other things, determining the lease term, discount rate, and the components of a contract can sometimes be challenging.
Even if the FASB’s delayed implementation is now upon us and you shouldn’t wait to get started. It’s time to start gathering all your leases, figuring out which ones fall within the scope of ASC 842 and begin performing the calculations. Starting now will give you ample time to understand the impact on your financial statements based on any lease-related changes to your balance sheet and work through any unforeseen challenges.
In addition, companies considering acquisitions or mergers should add a review of lease obligations and their impact on the balance sheet to their financial review and due diligence process.
Further to the financial statement implications, companies need to change their accounting policies and consider whether to make a number of policy elections, including whether to use several transition practical expedients. These available transition practical expedients may provide for some relief as it reduces the cost and complexity of transitioning to the new standard.
Contacting advisors and accountants should be a priority, in order to understand the details of the changes. Being proactive is key to avoid having qualifications appear on opinion reports if they fail to meet GAAP requirements.
The lease accounting standard changes have been in discussion for some time now, and the conversation ramped up around 2016. According to the International Accounting Standards Board, which launched the new standard along with FASB, companies around the world, at that time, had about $3.3 trillion of leasing commitments, 85 percent of which did not appear on balance sheets.
Contact me or another member of Kaufman Rossin’s assurance and advisory team to learn more about new lease accounting standards and how we can help you understand their potential impact on your balance sheet and financial statements.