The New Lease Accounting Standard is Already Here - Are You Ready?

Stone & Company Accounting and Auditing Update - August 22, 2022

Non-public companies that are required to issue financial statements in accordance with accounting principles generally accepted in the United States (GAAP) received some temporary relief when the financial accounting standards board (FASB) decided to delay the effective date of the new lease accounting standard (ASC 842) until years beginning after December 15, 2021. However, except for a few organizations with fiscal years in the latter part of 2022, most non-public reporting entities are now in the year that will require implementation and presentation of financial statements that meet the requirements under the new standard.

So what has changed and why?

The new lease standard is intended to include all leases in the financial statements, reflecting all lease obligations on the balance sheet, rather than excluding operating leases, as has been the practice in the past. All long-term operating leases now have to be capitalized. The FASB’s intent in issuing this new standard is to ensure that each organization’s true financial situation, including its obligations under leases, is reflected as accurately as possibly in the financial statements.

Under the new standard, all leases in excess of one year will be presented on the balance sheet as a right-of-use asset and a corresponding lease liability.

This is a principles-based standard and proper accounting involves important judgments, which will affect the amounts that get recorded.

Not all arrangements qualify as leases under ASC 842. The first step involves determining if the criteria are met for classification as a lease. The item leased must be a physical asset. The lessee must have the right to control or use the asset. The asset must be explicitly or implicitly defined in the arrangement. Accordingly, certain arrangements typically considered leases might not be within the scope of the new standard. Software subscriptions, leases for intangible assets, leases for exploration or use of non-renewable resources and leases of inventory or assets under construction would generally not meet the criteria for accounting under the new standard. However, office space, copies, computers and servers, equipment, vehicles and equipment are all within the scope of the new lease standard.

To implement the new standard, other important judgments will need to be made based on the specific terms within each lease arrangement. Payments to be made in renewal option periods must be “reasonably certain”.  Variable payments can only be included if they depend on an index or rate. “Finance Leases” under the new standard will need to be identified and defined, because the accounting is different from “Operating Leases”, even though both will go on the balance sheet. 

Other important areas of the standard with which the accounting and reporting must comply include the treatment of subleases and options to purchase the leased asset.

The disclosure requirements under the new standard are more extensive, with the objective of enabling financial statement users to better assess the amount, timing and uncertainty of cash flows related to leases. For example, for lessees, the new disclosure requirements, both quantitative and qualitative, include, among other requirements:

·       a description of leases

·       information about any terms or options to extend or terminate the lease 

·       descriptions of options recognized in calculating right-of-use assets and lease liabilities

·       terms and conditions of any residual value guarantees provided by lessees

·       information about leases that have not yet commenced but create significant rights and obligations
        for the lessee

·       information about significant assumptions and judgments made, including the discount rate for the
        lease

·       Total lease costs and related components

In summary, implementation of ASC 842 involves a significant effort for entities with multi-year leases and a requirement to issue financial statements that are in accordance with GAAP. Entities should ensure they engage in active discussion with their auditors as they implement the new lease standard.

For additional questions related to the new lease standard, contact your Stone & Company audit and assurance team. 

Bob Page, CPA, senior audit manager, contributed to this article. - Stone & Company, LLC, Lexington, Massachusetts - www.stonecpas.com