Renner Business News; December 15, 2022 — Joan M. Renner, CPA, CGMA
For years, you’ve been hearing about the new accounting principles that change how organizations account for leases. Although accounting standard setters have postponed the effective date of these requirements for years, there’s no more delay.
The new standard, contained in Accounting Standards Codification section 842 (ASC 842), applies to operating leases—like your office lease—as well as finance leases—like your copier. It applies to leases with terms greater than 12 months. It contains provisions for both lessors and lessees and applies to both for-profit businesses and nonprofit organizations. It applies to existing leases as well as new ones.
If your organization needs a clean opinion on GAAP financial statements, you’ll need to switch to the new rules on your December 2022 financial statements (or for your next year-end if you operate on a fiscal year). Basically, the time has come.
How the New Standard Works
For each of your operating leases, like your office lease, the new lease accounting standard adds a lease liability to your balance sheet. It will be the present value of all your future lease payments.
That’s right, all your future office lease payments will now be a liability on your balance sheet at present value. You’ll balance that out with a similar number on the asset side of your balance sheet, your right-of-use asset. A big new asset offset by a big new liability.
As you move through the lease term, your lease liability and right-to-use asset will gradually get smaller. You’ll recognize lease expense evenly over the life of the lease, and reduce the lease asset and liability based on the present value of remaining lease payments.
There are specific rules contained in the standard. There are also rules for switching to the new standard, which those with a calendar year-end must implement by December 2022.
The new standard also applies to finance leases, which we know as capital leases. You will need to apply the new standard to your equipment leases, but it may not result in a big change, as you already record them as assets and liabilities.
Why, Why, Why?
It may be hard to imagine why this is a better presentation, but this standard addresses real concerns. The old standard allowed two lease structures and one of them, operating leases, avoided the balance sheet. Inconsistencies between how different entities structured their leases made financial statements hard to compare. So, it’s valuable to have everyone report using the same rules.
When Does ASC 842 NOT Apply?
- This is an accounting standard, not tax law. If your organization does not produce GAAP financial statements, you don’t need to apply this.
- If you present financial statements but the users of your financial statements will accept financial statements with a GAAP departure, or financial statements prepared on the tax basis of accounting, you can avoid applying the new standard.
- Leases with a lease term of 12 months or less are not subject to the new standard. You must address probable renewals when determining whether the lease term is 12 months or less.
- Agreements that allow the lessor to benefit by substituting the use of one asset for another are generally not leases. A membership providing flexible space in an executive office suite may not be a lease.
- There are other exclusions for specific types of leased assets.
This is general information to help you understand the basics of the new lease accounting standard and whether you need to apply it. There are a lot more details to know about applying the new lease accounting standard. Contact us for more information.
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