The Financial Accounting Standards Board's (FASB) new lease accounting standard (ASC 842) has already been implemented by public companies. Due to the challenges surrounding the COVID-19 pandemic, private companies were granted an extension. Private companies are now required to implement the new lease standard for fiscal years beginning after December 15, 2021. For companies with a December 31 year-end, the new lease standard will need to be implemented effective January 1, 2022.

What can you do to prepare? Below are four steps to help ease the transition to the new lease standard.

  1. Identify all leases and gather supporting documents.
  2. Determine adoption method and policy elections.
  3. Estimate the impact of the new lease standard on your financials.
  4. Consider the impact of changes on bank requirements.

Due to the complexity of the new lease standard, today we will dive deeper into step 3. In addition, the guidance provided will be focused on the impact to lessees rather than lessors.

Estimate the impact of the new lease standard on your financials

The biggest change to a company's financial statements upon adoption of the new lease standard is the recording of a lease liability and an associated right-of-use asset.

Lease Liability

The lease liability is calculated as the present value of all future lease payments. Future lease payments should include all monthly rents, including any known payment increases and any extension periods that the company is reasonably certain to opt into.

When calculating the present value, all future lease payments should be discounted at the rate within the lease whenever possible. If that rate is not easily determined, management is allowed to use the company's incremental borrowing rate or make a policy election to use the risk-free rate when discounting the future lease payments.

Right-of-Use Asset

The right-of-use asset that gets recorded represents the value of the lease liability less any amounts already on the balance sheet related to the lease. These costs could include deferred rent or other direct costs or incentives.

Deferred and prepaid rent are concepts that go away under the new lease standard.

The Impact

The recognition of the lease liability and right-of-use asset upon adoption of the new lease standard, or the commencement of any new lease, will result in the grossing up of assets and liabilities, but only the difference between the asset and liability recorded, if any, represents the net impact to the balance sheet.

During each year of the lease agreement, the company will record either:

  1. Amortization and interest expense on a finance lease (previously capital leases) or
  2. Lease expense on an operating lease

This should generally not result in any change to the income statement from what was being recorded under the previous lease standard.

A few other tips to remember when performing these calculations:

  1. Financial statements will require the breakout of operating leases and financing leases, either on the face of the balance sheet or within the notes to the financial statements.
  2. Financial statements will require the breakout of a current and long-term portion of the lease liability.

If you need help making these calculations, estimating the impact to each aspect of your financial statements, and/or preparing the correct disclosures related to the transition to the new lease accounting standard, please contact our team today.

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