Newburg | CPA Tax Brief (9/27/21)

The Financial Accounting Standards Board (FASB) issued accounting standards update 2016-02 for leases in February of 2016 and subsequently issued ASUs 2018-01, 2018-10, and 2018-11 that provide practical expedients for transition and other codification and targeted improvements to the original ASU 2016-02. This new standard took effect in 2019 for public companies but the updated guidance was deferred to 2021 for private companies. The amended effective date for private companies and private not-for-profit entities is now for annual reporting periods beginning after December 15, 2021. Early adoption is permitted. We wanted to highlight some of the specific lease accounting changes within the standards that will impact how companies account for leases. The standard provides an option to apply the new standard at its adoption date instead of using the modified retrospective method as previously announced.

Accounting by the Lessor will remain relatively consistent with previous US GAAP with a few modifications made to the standard in order to align it with the new guidance on lessee accounting and the new revenue recognition standards, ASC 606. This alignment may be affected when you recognize variable consideration from a lease into revenue depending upon whether the transaction is subject to the revenue recognition or the lease accounting guidance. In addition, due to the changes set to occur in revenue recognition, more transactions may fail to qualify under sale and leaseback accounting which may impact how these transactions are currently being treated for accounting purposes.

Accounting by the Lessee has been significantly updated to increase transparency and comparability of financial statements by recognizing a right of use (ROU) asset and related lease liability on the balance sheet and disclosing key information with regard to these arrangements in the notes to the financial statements.

Please see a comparison of lessee accounting for finance and operating leases under ASU 2016-02 below:

ASU 2016-02 lessee accounting for finance and operating leases Comparison

-BDO, “FASB issues ASU on Leases”

Please note that the criteria for distinguishing between a finance lease and an operating lease are substantially the same as the criteria for distinguishing between a capital and operating lease under the old standard. In addition, the effect of these lease arrangements in the statement of comprehensive income and in the statements of cash flows is mostly unchanged from the old standard.

For any leases that are short-term in nature and are not expected to be extended past 12 months, the entity can elect a practical expedient not to recognize a right-of-use asset and lease liability on the balance sheet.

Please be advised that the implementation of this new accounting standard may have considerable effects on loan covenants and significant financial ratios. This is something to be discussed with lenders or potential lenders well in advance to ensure that the new lease accounting standards have been considered in determining loan compliance requirements.

In addition, significant changes in business processes may need to occur to track and implement the new standard effectively. It will be beneficial to understand how the different types of leases and possible payment arrangements may impact your balance sheet before entering into them as the structure could be altered to fit the needs of both parties. It may also be necessary to consider updates or enhancements to accounting platforms to ensure proper financial reporting and tracking of such arrangements.

Newburg | CPA hopes you found this brief overview helpful and recommends that you begin educating your management and accounting team on the topic as we approach the implementation date of this new standard. As you begin to analyze the impact of implementing the standard, Newburg | CPA would be happy to assist with any questions that may arise.