Although the new lease standard were originally issued by the Financial Accounting Standards Board back in 2016, many private companies are currently scrambling to implement the standard as they close their 2022 books. Private companies were required to implement the standard as of January 1, 2022 and there are no further delays allowed.
Accounting Standards Update 2016-02 amended lease guidance and generally requires all leases greater than 12 months to be capitalized and recorded as right-of-use assets and lease liabilities. The new standards maintained two categories of leases but removed the bright line rules included in the previous guidance and renamed capital leases to finance leases. Although there is no significant income statement impact expected from the implementation of the new lease standard, the impact on a company’s balance sheet could be tremendous, depending on the volume and length of their leases.
The Three Steps
If your company has not implemented the new lease standard and is in a mad dash to complete in order to close 2022, consider the following steps to get you to the finish line.
1. Prepare a complete listing of the company’s leases.
This includes all agreements that have a lease component. Office space, copy machines, vehicles, and equipment leases are the most common, but be sure to consider other contracts the company is party to that may not be labeled as a lease. If the contract conveys the right to control the use of a specified asset (e.g. plant, property, and equipment) over a period of time in exchange for consideration, there could be an embedded lease. For example, the sole use of a billboard for multiple years or use of specified railcars to transport goods.
2. Consider your software needs.
The standards and calculations can be complex and include detailed disclosure requirements. Not only are the operating lease costs and amortization of finance lease right-of-assets required, but so is the weighted average remaining lease term and weighted-average discount rate. Without a software resource that calculates these disclosures, significant time could be required to manually determine these. Many accounting firms, including PKF Texas, have partnered with software companies to bring cost-effective solutions to their clients and can provide a demonstration of the software. Before going out and searching on your own, contact your accounting service provider.
3. Define your implementation strategies.
There are several practical expedients in the guidance, and the company needs to make these elections prior to starting calculations to ensure consistent application of the standards and potentially reduce the time and energy required for compliance. Additionally, document all the decisions made as all practical expedients elected must be disclosed in the company’s financial statements.
- Decide whether to apply to all comparative periods that are presented in your financial statements or apply to only the current period.
- The suite of transition relief practical expedients allows the following:
- Companies are not required to evaluate expired or expiring contracts for lease components;
- Does not require companies to evaluate the lease classification of expired or expiring leases; and
- Does not require a reassessment of initial direct costs of leases already in place.
- Short-term leases with initial terms of 12 months or less are not required to be included.
- Note of caution: the lease term should include a consideration of renewal option periods if the company is “reasonably certain” to exercise those renewal options.
- Lease and non-lease components are allowed to be combined and not segregated, but the election needs to be made on a class-by-class basis.
- For example, a company can elect to use the entire monthly required payment, which includes a service aspect in calculating the right-of-use asset and lease liability for office equipment but elect to exclude the common area maintenance portion of the required payment for rent on their office space.
- Determine the interest rate that will be utilized in the calculations. For leases with no implicit rate in the agreement, the company needs to determine their incremental borrowing rate, or can elect to use a risk-free discount rate when calculating present value.
Once elections and implementation strategies have been decided, data input and calculations can be completed. It is then important to consider educating your stakeholders of the changes.
The new lease standard needs to be implemented as soon as possible. These three steps are a great start, but there might be some situations you need additional assistance. If you are struggling with navigating implementation, please contact us. Our team of Approachable Advisors™ are ready to collaborate and help you in making smart business decisions.