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 for private companies.

  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 1. In addition, the guidance provided will be focused on the impact to lessees rather than lessors.

Identify all leases and gather supporting documents

In order to be considered a lease, a contract (or a part of a contract) must include both

  1. "the right to obtain substantially all of the economic benefits" and
  2. "the right to direct the use" of the identified asset for a period of time in exchange for consideration.

While identifying leases can often be simple, this process can become more challenging when contracts include multiple components (lease component and a service component) or when both the supplier and customer have the ability to direct the use of the asset.

Contracts that include leases may i­nclude rent for office space, vehicles, machinery, equipment, photocopiers, and embedded leases, which are assets included in a service contract.

Certain types of leases are specifically excluded from the new lease accounting standard. Excluded leases include leases of intangible assets, biological assets (e.g., timber), nonregenerative resources (e.g., minerals, oil, natural gas, etc.) inventory, or assets under construction.

Once you have gathered the supporting documents for all potential leases, it is essential to identify the important information within the agreements. The new lease standard requires additional financial disclosures, so it is necessary to identify the following:

  1. Lease and non-lease components (service, maintenance, or insurance costs, etc.)
  2. Asset details: type, description, location, useful life
  3. Key dates: commencement, termination, early termination provisions, renewal provisions
  4. Payment terms: termination penalties, renewal term payments, variable payment terms (tied to sales or an index)
  5. Other information: lease incentives, initial direct costs, bargain purchase options, residual value guarantees, etc.

Once the lease and non-lease components of a contract are identified, management of your company will need to make a policy election regarding how they plan to report the different components. The various policy elections will be discussed in greater detail in following blog posts.

The key dates help determine the lease term, which should include renewals that are reasonably certain to be exercised and termination periods that are reasonably certain not to be exercised, as well as those periods which are controlled by the lessor.

The payment terms and other information help determine the classification of the lease. Leases for lessees will be classified as finance leases or operating leases, with classification being determined at inception of the lease and only being reassessed when a contract is modified and not accounted for as a separate contract (a change in whether renewals or terminations are reasonably certain to be exercised, etc.). The payment terms and other information also help calculate the right of use asset and associated liability. How to make these calculations will be discussed in greater detail in following blog posts.

Implementing the new lease standard may be simple or complicated depending on the quantity and complexity of each company's lease agreements. However, gathering all of the supporting documentation for every lease is an important first step in correctly implementing the new lease standard.

It is our mission to share changes that may affect our clients. At Delap, we’re committed to bringing you superior service and guidance that may impact private companies. If you have any questions on the new lease accounting standard, please contact our team today.

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