The Financial Accounting Standards Board (FASB) recently voted unanimously to reject an additional two-year extension to the new lease accounting standard effective date for nonpublic entities.

IMPLEMENTATION TIMING

Private companies and not-for-profits must adopt the new lease accounting standard for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. 

THE NEW STANDARDS

The lessee

Under the new standard, organizations that lease assets (the “lessee”) must recognize on their balance sheet the assets and liabilities they incurred in exchange for the rights and obligations under those leases. This requirement applies only to leases with terms of more than a year.

How the lessee will handle the recognition, measurement, and presentation of the expenses as well as the cash flows incurred by the lease will depend on whether the lease is classified as a “finance” or “operating” lease.  The distinction has a long history in earlier standards, where “finance” leases were referred to as “capital” leases.  Departing from current GAAP, however, which requires only “capital” leases to be recognized on the balance sheet, the new ASU requires both finance (capital) and operating leases to be recorded on the balance sheet.   

In addition to recording a right of use asset and lease liability on the balance sheet, there are also added financial statement disclosures. 

The right of use asset and lease liability are calculated by determining the present value of the future lease payments. Management must evaluate its lease agreements to identify the lease term and required lease payments and then use a reasonable discount rate to calculate the present value.

The lessor 

For organizations in possession of the leased assets (the “lessor”), accounting under the new regulations is largely unchanged from current GAAP. Nevertheless, the new ASU does impose certain changes that are intended to align lessor accounting with the new revenue recognition guidelines established under ASC 606.

GOALS OF THE NEW ASU STANDARDS FOR LEASE ACCOUNTING

Goals of the new standard include:

• Improving the representation of a lessee’s rights and obligations incurred by leases.
• Narrowing the opportunities for organizations to manipulate the structure of lease transactions to support certain presentations on their balance sheets.
• Making it easier to understand and compare the financial statements of various lessees.
• Aligning the lessor’s accounting, sale, and leaseback transactions with guidance already in place
• Providing users of financial statements with more information about the lessor’s leasing activities and the risks to the credit and assets of the lessee.
• Clarifying the definition of a “lease” within current GAAP practice.

WHAT IS THE EXPECTED IMPACT?

Companies with operating leases will likely see a reduction in their current ratio, as the lease liability will include a current portion with no offsetting current asset. Companies with finance (capital) leases are less impacted.

In most circumstances, companies are not expected to have a substantial income statement impact under the new ASU.

For private company reporting, the largest impact will be the explanation of balance sheet changes noted above to investors and working through possible changes in compliance ratios with lenders. Therefore, companies should work to identify all leases, communicate with owners and investors about upcoming financial statement changes, and work with lenders for any required changes to quarterly or yearly financial compliance reporting.

RELY ON LUTZ

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Contributor: Kyle Hofeldt