Implementing the updated accounting rules for leases
In late 2019, the Financial Accounting Standards Board (FASB) postponed the implementation date for its updated rules for leases, Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), by a year for most nonpublic and nonprofit organizations. Now, most of these organizations won’t have to implement the changes until 2021.
What is it?
The updated guidance aims to boost transparency for investors, lenders and other users of financial statements. To that end, it requires companies to include on their balance sheets a liability and a right-of-use asset of all operating and financial leases of more than 12 months.
While the delay provides some breathing room, complying with the changes remains a significant undertaking for most organizations. It requires them to identify all leases, including those embedded in other contracts, and assemble the information on them. Moreover, shifting more leases to the balance sheet may cause an organization to fall out of compliance with any loan covenants that limit the amount of liabilities it can carry, or that require a minimum working capital balance.
What steps should you take?
A starting point is to identify all leases, including those within other contracts, to pinpoint the information you’ll need to disclose. Leases that are parts of larger contracts might not initially look like leases. For instance, the right to use a piece of equipment as part of a service contract may count as a lease under the updated guidance.
Companies also may need to provide expanded disclosures on the nature of the leases, including related-party lease transactions, as well as finance and operating lease costs, among other information. Assembling and reporting this information likely will mean coordinating efforts across different departments, such as real estate, finance and IT. If your organization is party to more than a handful of leases, you’ll want to consider implementing lease administration software to manage the implementation process.
Along with administrative work, you’ll also need to assess how your organization will implement the changes. For instance, you can apply the updated standard either as of the earliest period presented in your organization’s financial statements or at the beginning of the adoption period.
Should you minimize lease obligations?
To limit the number of leases reported on their balance sheets, some companies may consider shifting some leases to terms of less than a year. But that can create other challenges. To start, leases of less than 12 months still must be disclosed in notes to the financial statements.
More important, shorter leases often come at a higher cost. In addition, if it’s a lease that you need to be renewed on a regular basis, you’re exposed to risk that the lessor will decide not to renew it.
The one-year delay provides time to talk with your lending partners about the potential impact of the updated standard on any loan covenants and to ask about adjusting the covenants to reflect this accounting change.
The delay also offers an opportunity to examine your organization’s use of leases to determine if it makes sense to shift some of them to asset purchases. Of course, this decision will depend on all business considerations — and not just on the way in which the asset is accounted for within the financial statements.
What’s the best approach for your organization?
The steps required to comply with the updated standard on an ongoing basis are wide-ranging, especially for organizations with large numbers of leases. To ease implementation for private companies, the American Institute of Certified Public Accountants’ (AICPA’s) Technical Issues Committee is continuing to discuss practical expedients with the FASB.
These include relief from weighted average disclosures and incremental borrowing rates. They’re also discussing providing specific materiality considerations for embedded leases. Your accounting professional can help your organization stay current and ensure that the actions you take to ensure compliance are the right ones.