New 2022 Lease Accounting Standards: What You Need to Know

Major changes in lease accounting are now in effect for privately owned companies and nonprofit organizations which will significantly impact how these organizations account for and report leases in their financial statements moving forward.

The Big Picture

Leases, including office, real estate, equipment, and vehicles, were classified into two categories: capital leases and operating leases. 

•  Historically, leases that were deemed an operating lease essentially had no balance sheet effect and were viewed as executory contracts therefore, lease payments were able to be recorded as an expense. 

With the new Accounting Standards Update (ASU) from the Financial Accounting Standards Board (FASB)—dubbed ASC 842—what used to be referred to as an operating lease are now referred to as a finance lease. Finance leases now record the rights and obligations of almost every lease on their balance sheet if the lease term is more than 12 months.

• Previously, capital leases reported the asset and lease liability on the balance sheet.  While ASC 842 changes the asset’s reporting name and classification, the method is essentially the same.

Why Did This Happen?

The FASB instituted ASC 842 in order to increase transparency of liabilities from leasing arrangements and reduce off-balance-sheet activity, while also aligning more with generally accepted accounting principles (GAAP) in other major countries. 

When Does It Take Effect?

For private companies (at the top we spell out privately owned and nonprofit), ASC 842 applies to fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022.

Why Does It Matter?

The adoption of ASC 842 won’t change your organization, but it may affect the way your financial results are viewed by outside parties. For example, you may find yourself with lower liquidity ratios, higher working-capital turnover and other balance sheet snafus that may impact compliance with financial covenants, or your ability to seek additional credit or investment.

New Rules. New Challenges.

For a lease to be subject to ASC 842, it needs to be a physical asset which you have the right to control or use. But part of qualifying a lease requires the separation of lease and non-lease components, the latter of which can include things like common area maintenance or service contracts. If there are multiple lease components, they may need to be tracked as separate leases on your books.

What Does This Mean for My Business?

Internal accounting teams will need to adapt new processes, adjust or create new monthly journal entries, draft additional disclosures and potentially even upgrade their technology to account for technical assessments.

How Can My Business Prepare?

Your organization should compile a complete listing of current leases and have related lease agreements readily available for your accounting, consulting or audit firm to review. It’s also important to define implementation strategies, determine updated software needs and educate lenders on the changes and how they impact the business.

The SMCPA Difference

SMCPA makes your life easier by assisting in the implementation of ASC 842. We help you get it right the first time so you don’t have to repeat the process, save you heaps of time by providing journal entries for the term of your leases and own the process so you can devote your resources to more important matters.

To learn more about how SMCPA can assist with your ASC 842 implementation activities, contact us now.