The new FASB lease standard (ASC Topic 842, Leases) is not here yet, but it is not too early to think about how this will impact your organization, especially if it is subject to debt covenants. Throughout 2019, we will highlight some of the nuances and concepts to begin preparing for in relation to this new standard.
The most talked-about impact of Topic 842 is the fact that lessees following U.S. GAAP will now recognize assets and liabilities from operating leases. The new criteria intends to provide financial statement users with a more complete picture of the extent of an organization’s right-of-use assets, and the impact on its future cash flows. Under current U.S. GAAP, assets and liabilities were not recognized for operating leases, only for financing leases. Therefore, this new standard is poised to significantly impact the balance sheet.
As you begin to consider this change, ask yourself, “What are my organization’s operating leases?” and begin keeping a log of these. The standard defines a lease as a “contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.” Under the new standard, organizations will recognize a right-of-use asset and a lease liability for nearly all of their leases associated with an asset (i.e., property and equipment). There are exceptions for leases with terms of less than 12 months and where there is not a reasonably certain expectation of renewal. For these shorter-term leases, organizations can elect not to recognize a lease asset and liability. Additionally, leases for services, or service contracts, are generally not required to be recognized as assets and liabilities.
The accounting for operating leases generally will be straightforward. Organizations will recognize a right-of-use asset and a lease liability on the balance sheet. Initially, both will be measured at the present value of the lease payments. On the income statement, organizations will recognize a single lease expense, which will include the charge-off of both the discount on the lease liability and amortization of the right-of-use asset. The lease liability will be amortized using the effective interest rate method, while the right-of-use asset will be amortized on the straight-line basis.
In summary, the key takeaways from this article are:
- Operating leases with terms over 12 months will now be recognized on the balance sheet as assets and liabilities.
- It’s not too early to start thinking about how this will impact your financial statements.
- Start a log of your organization’s current leases.
- Determine if you have any debt covenants that could be impacted by changes to the balance sheet.
- Consider changes to policies, procedures and internal controls related to the new standard.
As a reminder, implementation of this new standard becomes effective for non-public companies for fiscal years ending December 15, 2020, and after. Stay tuned as we will continue to highlight the nuances and impacts of this new standard as we move closer to the implementation date.
