How to adopt the new leasing standard for private companies

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In February 2016, the Financial Accounting Standards Board (“FASB”) issued its new guidance on accounting for leases in ASU No. 2016-02, Leases (Topic 842), referred to as ASC 842. The standard requires that lessees recognize for all leases (with a term of more than 12 months at the commencement date) the following: a) a lease liability, which is the lessee’s obligation to make lease payments arising of a lease, measured on a discounted basis, and (b) a right-of-use asset, which is an asset that represents the lessee’s right to use or control the use of a specified asset during the term of the lease.

Public companies have already adopted the ASC 842.

Private corporations with a calendar year end are required to adopt ASC 842 beginning January 1, 2022. Private corporations with a fiscal year end are required to adopt ASC 842 during the fiscal year. beginning after December 15, 2021.

If you have not yet adopted the leasing standard, consider these steps when evaluating the impact of ASC 842 on your business:

1. Identify your leases. Some common leases are for offices or buildings, photocopiers, postage meters, vehicles or equipment.
2. Evaluate integrated lease agreements.
3. Evaluate leases to determine the classification of leases as operating leases or finance leases.

  1. Finance leases meet one or more of the following criteria:
    1. The transfer of ownership occurs at the end of the lease term.
    2. The lease contains a provision that the lessee has an option to purchase the asset, and that option is reasonably certain to be exercised.
    3. The term of the lease represents the major part of the economic life of the asset.
    4. The present value of lease payments over the term of the lease, calculated at the inception of the lease, equals or exceeds substantially all of the fair value of the asset.
    5. The leased asset is specialized in nature such that it has no use other than the lessor.

b. Operating leases are any lease that does not meet the criteria of a finance lease.

4. Select a transition method:

  1. Comparative method – retroactively adjust prior comparative periods in the financial statements (all financial statements presented would take into account leases under ASC 842).
  2. Effective date method – accounts for leases under ASC 842 from January 1, 2022 without adjustment for prior years. Prior year financial statements would account for leases under ASC 840.

5. Consider practical expedients:

  1. The package of practical expedients, which must be elected together.
    1. No reassessment of lease classification for current or expired leases.
    2. No re-evaluation of integrated leases for existing or expired contracts.
    3. No reassessment of initial direct costs.

b. Retrospective, which allows lessees to make assumptions about the lease term and value of the right-of-use asset at inception using current information.

vs. Land easements – elect not to reassess existing or expired land easements as per the definition of a lease under ASC 842.

D. Short-term lease exemption that allows tenants to not capitalize leases with a term of twelve months or less at the start date of the lease (not the date of adoption).

e. Combine rental and non-rental components.

6. Determine the discount rate to use for present value calculations. Private companies may consider the applicable federal rate or use the company’s incremental borrowing rate as defined.

7. How many leases do you have?

  1. If you have more than a handful of complex leases or arrangements, consider using software that does the math for you. Rental software accomplishes several things. Lease information is kept in one place and easily accessible. Reports can be run for interim and year-end periods. Required footnote information is calculated by the rental software. Lease software reports aggregate leases to calculate right-of-use asset, finance or operating lease liability, lease expense, interest expense, and amortization expense.
  2. If you have less than a handful of non-complex leases, an Excel template may be appropriate for performing the lease calculations. The Excel templates are usually at some point, so if an interim report is needed, the Excel templates will need to be updated.

8. Complete rental calculations and record necessary adjustments in the general ledger.

9. Calculate your financial commitments as required by any loan or other agreement. Discuss the impact of ASC 842 with your banker before the end of the year, especially if you will need a covenant waiver.

10. Write the footnotes required for your financial statements. ASC 842 has many more disclosure requirements than previous guidelines. Footnotes should include a description of leases, an explanation of variable lease payments, terms and conditions of options to extend or terminate the lease, residual value guarantees, subleases, significant assumptions and judgments, treatment of rental costs, future deadlines, policy choices and practical expedients. Consider these requirements when drafting your leases.

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