For those of you on GAAP (Generally Accepted Accounting Principles) basis, a big change took effect on January 1, 2022, and after years of delay, the new lease standard, ASC 842 is finally in place. The purpose of the new standard is to increase disclosure and visibility into the leasing obligations of both public and private organizations by making it easier for stakeholders to see a company’s true financial position.
In the past, most leases were not included on the balance sheet – these were your operating leases for rental real estate agreements, vehicle leases, etc. The new lease accounting standard requires companies to report right-of-use (ROU) assets and lease payables for almost all leases. Previously, only capital leases, essentially purchase agreements, were required to be reported on the balance sheet. There was also a shift in terminology and what was once called a “capital lease” is now called a “finance lease”. This change applies not only to companies acting as the lessee but also to those that act as a lessor.
ASC 842 defines a lease as a contract that conveys the right-of-use of an identified asset for a specified period of time in exchange for payment. The identified asset can be property, equipment, or other tangible assets. Under this new standard there are finance leases, operating leases, and short-term leases. A Short-Term Lease is a lease with a term of 12 months or less and does not include a purchase option that the lessee is reasonably certain to exercise. This is the only type of lease that does not need to be entered on the balance sheet.
For ASC 842 implementation, there are two options: (1) adopt the new lease standard and change reporting and related accounting procedures for leases; or (2) do not adopt the standard and include a paragraph on your compilation or review report that this standard was not adopted.
The first option, adopting ASC 842, will require changes to lease reporting and accounting procedures and must be applied to both 2022 as well as 2021 if comparative financial statements are to be presented. Falco Sult would be happy to send guidance, examples, and assist you with implementing and applying the standard.
Under the second option, not adopting ASC 842 and including a special paragraph on your review or compilation report, your reporting and accounting procedures for leases would not change. If you are interested in this option, we recommend that you reach out to your third-party financial statement users (i.e., those requiring the financial statements such as banks, bonding, investors, etc.) and discuss if they approve of your company not adopting this standard and including a paragraph to this effect on the compilation or review report.
We would be more than happy to discuss these options with you, but this is ultimately a management decision.