USA: Lease accounting standards are changing

ASC 842 stands for Accounting Standards Codification 842, also known as the updated lease accounting standards being implemented by the Financial Accounting Standards Board. ASC 842 affects the way leases are reported under GAAP and introduces the right-of-use model that shifts from the risk and rewards approach to a control-based approach.

Overall, the FASB is updating lease accounting standards to improve clarity in accounting. The new standards will move off balance sheet leasing arrangements, like operating leases, on to the balance sheet which will allow investors and other uses of financial statements to more readily and accurately understand the rights and obligations associated with the leases a company is beholden to. Additionally, the new lease standard will increase transparency and comparability among organizations that lease buildings, equipment, and other assets by recognizing the assets and liabilities that arise from lease transactions.

This change in compliance isn’t quite as simple as transferring where you’re reporting your leased assets. Previously, there were two ways to classify a lease:

• • As a “capital” lease, where ownership of the asset transferred to the lessee. Capital leases were recorded on the balance sheet.
  • As an “operating” lease, where only the right to use the asset transferred. Operating leases were not included on the balance sheet, but were disclosed in the footnotes of the financial statements.

With the new lease accounting standards, you’ll want to take each lease individually and assess how you will account for the leased asset:

• Month-to-month leases: Review any current leases you have listed as month-to-month. If the asset is solely used by the lessee and the lessee is guaranteeing the debt by providing the cash flow necessary to service the debt, then a longer lease may be appropriate.
• Related-party leases: Although these leases may be a month-to-month or under 12 month arrangement, depending on the situation, if the arrangement functions more like a longer-term lease, it must be recorded on the balance sheet.
• Job costing: The new lease standards directly affect how you report leases that are alleviating a debt. Accurately capturing your job costs will likely change, depending on what the cash flow of paid leases provide to your business.

While the new reporting standards do not change the core economics of your business, certain important finance ratios may shift. If your company currently has a number of off-balance sheet leases that, going forward, will be recorded on the balance sheet, it is a good idea to meet with your lenders and sureties about the potential changes in your reporting. A sudden increase in liabilities on a balance without prior warning or explanation may trigger cause concern with lenders, so it’s best to make sure everyone is on the same page. Depending on your situation, you may want to discuss updating the terms of any covenant to build in needed flexibility to prevent violations brought on by any potential future changes to accounting standards. The new leases standard also will require lessees and lessors to provide additional qualitative and quantitative disclosures to help financial statement users assess the amount, timing, and uncertainty of cash flows arising from leases. These disclosures are intended to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an organization’s leasing activities.