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Even though the Financial Accounting Standards Board (FASB) has extended the deadline for private businesses and nonprofits to comply with new lease accounting rules – now applicable to fiscal years beginning after December 15, 2021 and in fiscal interim periods beginning after December 15, 2022—organizations cannot afford to wait any longer before acting on implementation.
FASB Accounting Standards Update (ASU) 2016-02 (“Topic 842” or “the new standard”) applies to both lessees and lessors and makes significant changes to balance sheets. The additional time granted by the FASB reflects the daunting task ahead, which will require more work, more resources and more time than most companies realize.
UNDERSTANDING THE NEW STANDARD: FREQUENTLY ASKED QUESTIONS ABOUT RENTAL ACCOUNTING
What is Lease Accounting (ASC 842)?
CSA 842, Leases, provides financial accounting and reporting requirements for tenants and lessors. This standard establishes the right-of-use asset model, which moves from a risk-reward approach to a control-based approach. Under the new standard, lessees will recognize an asset on the balance sheet, representing their right to use the leased asset over the term of the lease and recognizing a corresponding lease liability to make lease payments. The lease liability is based on the present value of future lease payments using a discount rate to determine the present value based on the rate implicit in the lease, if readily determinable, or the borrowing rate lessee’s marginal. As a result, a lessee’s operating lease accounting model will change significantly. The added complexity of the new standard requires leases to be classified as either finance leases or operating leases.
What changes can I expect?
Finance leases will separately recognize interest expense on the liability and amortization expense on the right-of-use asset. The periodic charge at the beginning of the lease term will generally be greater than the corresponding cash payments, but will decrease over the term of the lease as the liability is reduced. Operating leases will recognize rental expense on a straight-line basis over the term of the lease as a single line item within operating expense in the income statement.
For lessor accounting under ASC 842, a sale and the related profit are recognized at the inception of the lease only when the arrangement transfers control of the underlying asset to the lessee. The changes to the new guidance align with the new revenue recognition standard, ASC 606, because leasing is fundamentally a revenue-generating activity for lessors. ASC 842 also requires additional disclosures regarding the lessor’s exposure to asset risk and credit risk. Lessors will classify the lease as a purchase lease, a finance lease or an operating lease.
ASC 842 provides various practical expedients for lessee and lessor, for example, non-separation of lease and non-lease elements, short-term leases, capitalization thresholds, setback, and land easement.
ASC 842 also provides guidance for determining whether an arrangement contains an embedded lease, where an express or implied asset identified in the lease is controlled or used by the lessee.
What challenges can I expect?
This standard represents a radical change in the accounting for leases; therefore, many entities will face significant implementation challenges such as:
- Failing to identify leases embedded in arrangements.
- The number of arrangements that were previously not identified as leases can now be identified as meeting the definition of a lease or an integrated lease.
- Existing systems and processes may need to be modified or enhanced to provide the information needed to meet new reporting and disclosure requirements.
- Several departments in the organization will be affected by this standard, including information technology, tax, legal, treasury, and financial planning and analysis, among others.
- Ongoing efforts may be greater than the initial implementation effort.
This standard includes detailed information intended to enable users of financial statements to understand the amount, timing and judgment associated with a reporting entity’s recognition of leases and related cash flows. This standard requires the disclosure of qualitative and quantitative information about leases.
Why is lease accounting important?
ASC 842 establishes principles that lessees and lessors should apply to provide users of financial statements with meaningful information about the amount, timing, and uncertainty of cash flows arising from a lease.
Who is affected by the recognition of leases?
Lease accounting affects all entities that lease assets, including real estate, aircraft and equipment. The standard excludes leases of intangible assets; leases to explore or use non-regenerative resources; and leases of biological assets, inventory and assets under construction.
What is the deadline for adopting the lease accounting standard?
In June 2020, as a result of the COVID-19 pandemic, the FASB extended the implementation deadline for the new standards on leases for all other entities and public purpose entities. nonprofits that had not yet published their financial statements. statements.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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