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Is your business ready for the new lease accounting standard?
Article | December 22, 2021
The way private companies account for their leases is about to change dramatically, and accountants and companies alike need to be ready.
The change comes from the Financial Accounting Standards Board, also known as FASB, which issued a rule in February of 2016 known as Accounting Standards Update (ASU) 2016-02. After numerous deferrals since the rule was first published, the bill is finally coming due and private organizations will be held to that standard beginning after December 15, 2021. Interim periods have slightly more time, with an effective date of December 15, 2022. Public organizations were mandated to adopt the methodology in 2019.
Here’s what you need to know about the change, and how you can prepare.
Put simply, the new changes implemented by FASB requires that any lease with terms that extend past one year must be documented as a right of use asset, and be accounted for as such on balance sheets. The asset class broadly means that the owning or leasing organization has the right to use the asset, and it’s total balance includes payments, costs, or incentives. Those income and expenses are the main concern for newcomers to the rule.
Included in the policy are real estate, vehicle, office supply, and building leases, although there are several exceptions to the rule. Leases that are shorter than a year in length will not have to abide by the new standard.
Why should I care?
Private companies should care because it entails moving lease assets and liabilities to their balance sheets, something only applied to financing transactions prior to this guidance. Under the previous rule, companies could use loopholes that applied rules for rental agreements to leasing agreements, thereby averting a balance sheet and keeping expenditures lower overall. Doing so offered a better, but less realistic, financial outlook in many cases.
The new FASB guidance puts those costs on the balance sheet, meaning that financial documents for private companies could be shifted dramatically depending on how many leases the company transfers over.
When should I make the transition?
Yesterday. While the industry consensus is generally that the new accounting methods are overall healthier and more realistic for balance sheets, making the change can be logistically challenging depending on the scope of leasing agreements.
Companies should take this into account when making the changes, and be aware that the costs and time commitments make it a transition that should not be done at the last minute. Doing so has the potential to lead to inconsistent or incomplete work attributed to racing against a deadline.
What should I do to prepare?
Whether you are in the beginning stages of transferring to the new accounting protocols, in the middle of a transfer and need to double check best practices, or finished the transfer totally and second-guessing the process, there are four things that every company should do if the switch applies to their balance sheets.
- Know the full picture of the task at hand. This will help the company get a better understanding of just how much work needs to be done. While it may seem as simple as going into the “leases” folder with a general counsel, the true difficulty lies in discerning the leases that reside in other contractual documents that may not at first seem lease-related. Such is often the case in contracts with service components or multiple users of a resource.
- Compile the details. The financial requirements in FASB dictate that certain data must be included in financial reporting, including lease and non-lease components, important dates, terms of payment, and details about the leased asset. Each contract will need to be analyzed in tremendous detail so not to leave any of the information out.
- Determine how the rules will be adopted. There are two separate ways that companies can implement the new methodology, one of which must be followed in order to correctly share the data internally and externally. The first is with both years restated under ASC 842, and the other only records the current year under the rule and using a cumulative effect adjustment.
- Estimate the overall impact of FASB. The best way to prepare for the financial impact is to know as much as possible, and the best way to know as much as possible is to make an educated guess on what the overall impact of the change will be. Doing so will likely be difficult and imprecise, but working with an experienced team of attorneys and accountants companies can calculate a more detailed picture of what their financial outlook will be in the years to come under the new rule.
If you and your company are at any stage of the FASB leasing transition and would like a helping hand, or have completed the transition and are interested in best practices for the presentation of financials going forward, please don’t hesitate to reach out to our team.
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