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Time’s almost up! Is your 2022 balance sheet compliant with new ASC 842 GAAP standard?
ASC stands for accounting standards codification, and GAAP stands for generally accepted accounting principles. The ASC US GAAPs are a set of accounting standards released and maintained by the Financial Accounting Standards Board.
ASC 842 is the new lease accounting standard for private and public companies reporting under US GAAP. The standard is effective for public and private entities with fiscal years beginning after December 15, 2018, and December15, 2021, respectively. For private companies with a calendar fiscal year, the implementation date is January 1, 2022. Prior guidance was ASC 840.
Lessees reporting under Topic 842 are required to recognize both the assets and the liabilities arising from their leases. The lease liability is measured as the present value of lease payments, while the lease asset is equal to the lease liability adjusted for certain items like prepaid
rent, initial direct costs, and lease incentives. ASC 842 is mandatory for all private companies that have leases longer than 12 months.
The purpose of ASC 842 is to bring most operating leases, which are currently accounted for off-balance sheet, onto the balance sheet enhancing visibility. It’s anticipated that this change will put “$3 trillion in liabilities on corporate balance sheets.” https:// www.cnbc.com/2019/02/15/a-big-change-in-accounting-puts-3- trillion-on-corporate-books.html
In recording the leases, the following determinations must be made which may not align with the contract.
- Determining commencement date – The new standard defines commencement date as the date on which a lessor makes an underlying asset available for use by a lessee. This date is fact specific and may not be the same as the commencement date as defined in the contract. In arrangements with many assets, it’s possible there may be multiple commencement dates when assets are delivered at different times. Commencement date matters because it’s the date that the lease is classified and balance sheet and income statement recognition begin.
- Determining lease term – Lease term directly impacts the classification, measurement and recognition of a lease. The lease term is never shorter than the noncancellable term to which the lessee is subject. However, leases often include optional periods that permit a lessee to extend its use of an asset. Contracts may also include termination options that can impact the lease term used for classification and measurement.
- Determining lease payment – Lease payments are an important factor in lease classification and measurement. Under ASC 842 fixed payments allocated to a lease component(s) are discounted and compared to the fair value of the asset to
determine whether the lease is an operating lease or a finance lease. Regardless of classification, the discounted payments are recorded as a lease liability and are the starting point for measuring the right-of-use asset. The right-of-use asset may be subject to further adjustment for items such as prepaid rent.
It’s important to keep in mind the overall disclosure objective of 842 “which is to enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases”. It’s up to the organization to determine the level of details and emphasis needed on various disclosure requirements to satisfy the disclosure objective. With that objective in mind, significant judgment will be required to determine the level of disclosures necessary for an entity. However, simply put, the more extensive the organization’s leasing activities, the more comprehensive the disclosures are expected to be.
If you have questions about finance or operating leases, or need help with the new standard, Amy Calandrino and the Beyond Commercial team has numerous resources available and do not hesitate to reach out.