Lease Accounting Standard Update

The new lease accounting standard issued by the Financial Accounting Standards Board (FASB), aptly named “Leases (Topic 842),” is effective for private companies with fiscal years beginning after December 15, 2021 and effective for calendar year filers on January 1, 2022.  After the FASB approved a one-year deferral of Topic 842 due to the COVID-19 pandemic, the effective date is fast approaching.

The new lease accounting standard requires all lease agreements greater than 12 months (excluding lessor agreements) to be recognized on the balance sheet as a right of use (ROU) asset and a lease obligation.  The ROU asset should be determined based upon a discounted cash flow analysis.  Careful consideration will need to be given to the impact that the ROU asset and lease liability will have on financial reporting and covenants.

The following are common areas of misunderstanding with respect to Topic 842 implementation:

• Do all potential lease agreements need to be addressed?  The new guidance not only applies to explicit contracts (for example, one with the term “lease” in the title), but also applies to implicit contracts, referred to as embedded leases, within service contracts. Many service contracts rely on the use of underlying assets. Those assets will now need to be reported in the financial statements.
• What if a lease covers the right to control the use of multiple assets?  The new standard requires the identification and separation of these components. The sole exception is if the accounting impact of not separately accounting for these assets is determined to be insignificant.
• Does a certain rate need to be used for the calculations?  The new guidance requires the rate implicit in the lease (RIIL) to be determined.  If you are unable to determine the RIIL, the incremental borrowing rate must be computed.

Performing the necessary analysis and calculations of Topic 842 will require significant time and resources. Lease schedules will need to be created and maintained to track ROU assets and lease obligations over time, journal entries will need to be posted monthly, and footnote disclosures will need to be drafted to accompany financial statements.  CLA offers several lease accounting services, including an affordable turnkey solution.  Don’t wait; the implementation clock is ticking! 

Big thanks to colleagues Stephen Schiltz, Walker Wilkerson and Jonathan Young for their assistance with this post.