United States: The New Lease Accounting Standard Is Finally Here – Are You Ready?
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After repeated postponements by the Financial Accounting Standards Board (FASB), the new lease accounting standard is expected to finally come into effect for private companies for fiscal years beginning after December 15, 2021 (2022 for end-of-life companies). calendar year). Found in Accounting Standards Codification (ASC) 842, the new standard applies to all companies that report their financial results in accordance with US generally accepted accounting principles (GAAP). Although ASC 842 will require lessors to make changes to how they report leases in their financial statements, its greatest impact will be felt by lessees, especially those whose leases are currently classified. such as operating leases.
Impact on the balance sheet
The new standard generally retains the distinction between operating leases – which give the lessee the right to use the leased asset during the term – and capital or “finance” leases – which transfer ownership of the asset to the lessee. at the end of the term. However, unlike the current standard, which allows operating leases to be treated as off-balance sheet transactions, the new standard will require lessees to record all leases with a term longer than 12 months on their balance sheet.
When the new standard becomes effective, lessees will record a “right-of-use” asset, which represents their right to use the leased asset for a period of time. They will also record a corresponding liability equal to the present value of the lease payments. In particular, the new standard classifies operating lease liabilities in the category of “operating liabilities” rather than grouping them with finance lease liabilities and other “debts”.
Impact on loan covenants
Lessees should assess the potential impact of the new standard on their lending commitments with banks and other lenders. The FASB’s intention in classifying operating lease liabilities separately from traditional debt on the balance sheet was to minimize the impact of the standard on borrowers, whose loan covenants may require them to maintain a certain debt-equity ratio or a certain level of debt service coverage. However, depending on how a loan agreement defines “debt”, adding new liabilities to the balance sheet may cause some borrowers to violate these covenants. Similarly, the new standard may result in violations of covenants related to liquidity measures, such as the ratio of current assets to current liabilities.
Changes in the way operating leases are presented in financial statements do not affect a company’s cash flow, so most lenders will be willing to adjust their covenants accordingly. But it’s important that borrowers discuss the potential impact with their lenders before implementing the new standard to avoid technical breaches of their covenants.
Treatment of short-term leases
As noted above, the new standard requires tenants to record all leases longer than 12 months on their balance sheets. However, they can choose not to register leases with a duration of 12 months or less, but that does not mean that a tenant can keep leases off their balance sheet using a 12 month duration. For the purposes of the new standard, the term of a lease includes the initial non-cancellable period, more all renewal options that the lessee is reasonably certain to exercise, taking into account all relevant economic incentives (for exampleinvestments in tenant improvements, relocation costs).
In addition to assessing the impact of the new lease accounting standard on their financial statements, companies should also ensure they have systems and processes in place to track and report their lease activities.
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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