Are you prepared to implement the new lease accounting standard?
The new lease accounting standard goes into effect for annual reporting periods beginning after December 15, 2021, or the 2022 calendar year, for non-public entities, including private companies and not-for-profit organizations. The standard requires entities to recognize on the balance sheet virtually all leases with initial terms in excess of one year, including separate accounting models for finance and operating leases.
Important Lease Accounting Changes
Those who have started to implement the new lease accounting standard have discovered that the time and resources required should not be underestimated. The decision to delay the effective date for private entities was mostly to allow these entities to learn from the implementation of the standards at large public companies that can leverage more resources. Much of the time required for its implementation is being spent gathering the relevant data and performing the analysis needed to comply.
Finance Leases
The right to use asset and lease liability are calculated based upon the present value of the lease payments. The asset is amortized and the interest on the liability are recognized separately within the income statement. On the statement of cash flows, the principal portion of the payments are classified as a financing activity and the interest portion of the payments are classified as an operating activity.
Operating Leases
Like finance leases, the right to use asset and lease liability are initially calculated based upon the present value of the lease payments. However, the cost of the lease is then allocated over the lease terms on a straight-line basis and presented as a single expense on the income statement. On the statement of cash flows, all lease payments are classified as an operating activity.
What Discount Rate is Appropriate When Calculating the Initial Value of a Lease?
The discount rate is an important element in the calculation of the initial value of a lease liability and right-of-use asset. The new lease standard offers three discount rate options from which non-public entities can choose. Each have benefits and drawbacks, including the difficulty in calculation and the impact to a lessee’s balance sheet. These are the three potential discount rates allowed under the new guidance:
- The rate implicit in the lease;
- The lessee's incremental borrowing rate;
- If the lessee is a non-public entity, a risk-free discount rate
Lessee Financial Statement Disclosures
Lessor Financial Statement Disclosures
Co-working and Office Space Leases
The new lease standard is expected to increase the total assets and total liabilities of privately-held companies, including non-profits who lease office space for back office or administrative operations. While an office lease may be a company’s only lease, and the company may not be in the business of “owning real estate”, the right of use asset and liability will now be included on the company’s balance sheet.