Some are calling the new lease standard the biggest accounting change of this generation. While the accounting profession moved the goalposts on its effective date for years, the time is finally here for organizations to implement the sweeping changes brought about by FASB’s Accounting Standards Codification(ASC) 842, Leases.
The changes that the new lease standard brings are substantial and can impact any business or nonprofit that has at least one lease. Here’s a brief rundown of what you need to know about this new accounting standard and how it will impact your organization’s financial statements.
What exactly is the new lease standard?
Under the new lease standard, long-term leases (generally a lease with a lease term greater than 12 months) will be reported on the balance sheet. The lessee will record a right of use asset (ROU) and lease liability equal to the present value of payments expected over the lease term.
This is a major departure from the old lease standard, which only required leases meeting certain criteria to receive this accounting treatment (i.e., capital leases). The significance of this change cannot be understated as it will impact all readers of financial statements, including lenders and bonding agents. While the definition of what a lease is has changed slightly under the new standard, most businesses that have leases will be affected in some way by ASC 842.
Why the need for the new lease standard?
The new lease standard was created so that financial statement users would have a better understanding of the financial commitments of a business or nonprofit organization.
Under the old lease standard, many leases were considered operating leases. With an operating lease, there is no real transfer of ownership. As a result, the lessee simply records all lease payments as expenses.
Under the new lease standard, the reporting of an asset and liability related to a lease is determined based on lease term. If the lease term extends past 12 months, the lessee will now be required to record the leased property as an asset, as if it owned the property outright and a corresponding lease liability. The idea is that the new standard will provide greater transparency to readers of financial statements by reporting lease information directly on the face of an entity’s financial statements instead of the footnotes to the statements, also referred to as disclosures.
What kinds of businesses are impacted by the new lease standard?
Any business that leases property, plant and equipment (such as office space, office equipment and vehicles) will be affected by this new lease standard.
Are nonprofit organizations subject to the new lease standard?
Yes. Any nonprofit that leases property, plant and equipment (such as office space, office equipment and vehicles) will be affected by this new lease standard.
When does the new lease standard take effect?
The new lease standard takes effect for fiscal years beginning after December 15, 2021. That means that calendar year-end businesses and nonprofits will see substantial changes on their financial statements for the year-ended December 31, 2022. Businesses and nonprofits that operate on a fiscal year-end will not see any changes until year-end 2023.
Are there any other considerations?
Businesses and nonprofits that have loan covenants may be negatively impacted by the new standard as it will increase both current and non-current liabilities. If you have loan covenants, we recommend that you discuss the new standard — and its impact on your ability to meet those covenants — with your banker.