Category: Audit, Advisory and Assurance
What is the new lease standard and why is it important?
The technical standard you will see reference to is ASU No. 2016-02, Leases (ASC Topic 842) and this was issued by the Financial Accounting Standards Board (FASB) in February 2016 (referenced as ASC 842 going forward). The major change, as a result of the implementation of ASC 842, is that nearly every lease will be recognized on the balance sheet by the way of a lease obligation (liability) and corresponding right-of-use asset (asset). Prior to implementation, your operating lease payments would be posted directly to the income statement as a lease expense and there would be no sign of lease-related liabilities or assets anywhere on your balance sheet, unless you had existing capital leases.
As a result of ASC 842, the financial statement presentation of your leases will be substantially different and will have an impact on major financial metrics such as working capital and debt to equity.
Does the new lease standard impact me?
If you have any existing leases, or plan to enter new lease arrangements, the implementation of ASC 842 will have an impact on your financial statements. Necessary steps will need to be taken to assess each one of your leases to ensure they’re properly identified, and that the necessary adjustments are made to record the leases on your balance sheet.
What are the categories of leases and how will they look on my financial statement?
Under ASC 842, each lease will be classified based on five criteria (transfer-of-ownership, option-to-purchase, economic life, fair value, and alternative use). Alternative use is a new criteria added under ASC 842; the other four criteria existed under previous standards. Based on the results of the criteria, each lease will fall into one of the following categories:
When do I need to adjust my lease accounting process?
You need to begin considering the implementation of ASC 842 today! While early adoption was permitted, the mandatory implementation date is for fiscal years beginning after December 15, 2021 (an earlier implementation date of December 15, 2019 was required for certain entities). This means that all calendar year-end entities will be required to implement ASC 842 in 2022.
If you issue interim reports, interim periods are not required to implement ASC 842 until those interim periods fall within fiscal years beginning after December 15, 2022.
What should I do to start the process?
Compile all your existing lease agreements to be tested, on an individual basis, to determine proper treatment. Also, begin discussing the impact of ASC 842 on your covenant calculations with your lender.
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