After various covid related deferrals of effective dates, the Financial Accounting Standards Board’s (FASB) ASU 2016-02, and its governmental counterpart, the Governmental Accounting Standard Board’s (GASB) 87 are finally effective, and must be adopted, beginning with June 30 2022 and subsequent year-ends. These new standards on accounting for leases require organizations to recognize most leases on their balance sheet, which is a significant change from previous accounting requirements. This new guidance will affect a significant number of entities across all industries because most companies enter into contracts that are, or contain, leases to support their business operations. The standards’ modified retrospective transition approach also requires entities to reflect the effect of the new guidance in the earliest year presented in the financial statements, meaning that comparative statements with both 2022 and 2021 will require a change to the prior year presentation.
The new standards’ scope includes leases of all property, plant, and equipment. At lease inception, a lessee evaluates the terms of a contract to determine whether the contract meets the definition of a lease under the standards and, if so, whether the lease is a finance lease or an operating lease. At initial recognition of the lease, a lessee measures the liability for its lease obligation at the present value of lease payments not yet paid (excluding variable payments) and records the liability, along with a corresponding “right-of-use” asset.
Subsequent adjustments are dependent upon whether the lease is classified as a finance lease or an operating lease. A finance lease results in a front-loaded expense profile with an interest component while an operating lease generally results in straight-line amortization of the right-of-use asset.
The new standard represents a wholesale change to lease accounting. As a result, entities will face significant implementation challenges during the transition period and beyond, such as those related to:
- Applying judgment and making estimates.
- Managing the complexities of data collection, storage, and maintenance.
- Enhancing information technology systems to ensure their ability to perform the calculations necessary for compliance with reporting requirements.
- Refining internal controls and other business processes related to leases.
- Determining whether debt covenants are likely to be affected and, if so, working with lenders to avoid violations.
- Addressing any income tax implications.
In the near term, entities should determine what systems and processes they will need to properly adopt the guidance and consider that additional time and effort, both within the organization as well as from our personnel, may be required upon adoption in 2022. Our team is ready and able to assist your organization with this significant transition process.