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After several delays by the Financial Accounting Standards Board (FASB), the new lease accounting standard has finally taken effect for nonpublic companies for fiscal years beginning after Dec. 15, 2021.
The new standard, found in Accounting Standards Codification (ASC) 842, applies to private companies and not-for-profit organizations that report their financial results in accordance with U.S. Generally Accepted Accounting Principles (GAAP). Lessors will be required to make some changes on how they report leases on financial statements, but the more significant impact will be for lessees.
According to the ASC 842, the new rules are primarily designed to “increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing transactions.”
To comply with the standard’s requirements, an entity must record assets and liabilities relating to all leases on the balance sheet and add various new disclosures in the financial statements notes.
For the most part, ASC 842 preserves the distinction between operating leases — which give the lessee the right to use the leased asset during the term of the lease — and finance leases (formerly capital leases) — which transfer ownership of the asset to the lessee at the end of the term.
While both types of leases are now recorded on the balance sheet, there are differences in the accounting process for each.
Under the previous standard ASC 840, lessees could not record a finance (capital) lease asset that was greater than the fair value of the asset. ASC 842 requires the asset be recorded at the amount calculated using the appropriate discount rate, even if this amount is greater than the fair value of the asset.
Lessees are now required to record a right-of-use (ROU) asset, which represents their right to use the leased asset for a period, along with a corresponding lease liability equal to the present value of the lease payments. The ROU asset is equal to the lease liability plus any initial direct costs and prepaid lease payments and minus any lease incentives. The lease liability is measured by taking the present value of all remaining lease payments, while the present value of the lease amount is determined by the lease term and the discount rate.
The new standard ASC 842 requires lessees to record all leases with terms greater than 12 months on their balance sheets. Anything shorter than that is defined as a short-term lease, which lessees can choose not to record on their balance sheet. They can instead just recognize a lease expense on a straight-line basis.
However, ASC 842 states that if the lease agreement includes a lease renewal option that the lessee is reasonably certain to exercise, then the lease term should account for such option.
This could push many leases which otherwise would be deemed short-term into the territory of required presentation as ROU assets and lease liability on balance sheet.
ASC 842 boasts several more qualitative disclosures than its predecessor ASC 840, including:
For lessors, the new or expanded disclosures will also be required to include:
Keeping your business compliant
While the requirements for the new lease standard may seem complicated or overwhelming at first, help is available to keep you and your business compliant.
If you have any questions about the information above, please contact your E. Cohen advisor.
