The update of the accounting rules for emphyteutic leases came into force in 2019 for public companies. Now, after several postponements by the Financial Accounting Standards Board (FASB), private companies and private not-for-profit entities must follow suit. The new standard will apply to annual reporting periods beginning after December 15, 2021 and to interim periods of fiscal years beginning after December 15, 2022.
Unlike current generally accepted accounting principles (GAAP), which requires only capital leases to be recognized on the balance sheet, the new guidance requires a lessee to recognize right-of-use assets and liabilities associated with all long-term contracts. rents on the balance sheet for leases with a duration of 12 months or more. The magnitude of recognized right-of-use assets and liabilities will be determined as the product of the lease term, required payments and the applicable discount rate used to calculate the present value of these obligations. While entities may be tempted to automatically exclude monthly leases or leases of 12 months or less, the guidance specifies that adopters should use an “expected outcome” approach and should consider other factors. economic when determining the applicable rental contract. term.
The new standard also mandates changes to disclosures to help users of financial statements better understand the amount, timing and uncertainty of cash flows arising from leases. Companies will have to disclose, in the notes to the financial statements, more information about the nature of their leases, the significant judgments made in applying the requirements of the new standard and various other amounts and characteristics related to particular leasing activities. . This area is probably the biggest change that would require the help of a CPA to make sure all the bases are covered.
Implementing the new rental standard could take more time and money than most organizations realize. There are several specific issues that you will need to address carefully to ensure a cost effective and successful transition to the new standards. To help you chart a course for success, prepare thoughtfully in these areas:
- Compile a complete population of your leases, along with applicable lease terms and required payments. Collecting all the lease documents can be difficult and time-consuming, but it will help you have a clear idea of exactly what you will need. Remember to look for related party leases, even if they are not written.
- Select the best rental software for your business needs. You’ll need to look at style and functionality to determine which best suits your business needs. This software can help keep your business costs down while ensuring a smooth transition to the new normal.
- Identification of integrated leases. Maintenance or service contracts can be described as a lease, but contain identified assets that are controlled by your organization, making it an “integrated” lease. Under the new standard, you will need to capitalize this type of asset and reflect it on your books, making it an important, but difficult type of lease to locate.
- Decide which discount rate you should use. There are a few choices for discounting your lease payments to present value and then capitalizing on your books, which may use implied rates, incremental borrowing rates, or risk-free rates, but these may also have an impact. on the parameters, including covenants of banking ratios.
- Work with your accountant. Communicate early with your auditor or accountant to understand their process for auditing or reviewing leasing activity and financial statement reporting to help you develop internal accounting policies, procedures and internal controls around the new rental standard.
It is important that you test the application of the new directives to see their impact on the presentation of your balance sheet. The right-of-use asset recognized under the new guidance would be classified as a non-current asset, while the current portion of the lease liability would be classified as a current liability. This could potentially have a material adverse impact on working capital, fixed charge ratios or similar liquidity and liability ratios. What was once considered a healthy business may now appear to be low credit risk, and the diminished ability to obtain financing could have a real negative effect on the financial health of the business.
If you have questions or need help implementing the new rental standard, please contact one of the professionals at Dannible & McKee, LLP. Visit dmcpas.com to learn more.