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Considerations Around the New Leasing Standard

With the impending effective date for private companies of Accounting Standards Update (ASU) 2016-02 Leases, a company will be required to evaluate its lease portfolio and record right-of-use assets (“ROU assets”) and lease liabilities on its balance sheet for its operating leases. There are numerous considerations that go into determining the amounts to be recorded related to the implementation of this standard including the discount rate, remaining lease term, remaining lease payments, practical expedients, and accounting policy elections, amongst many others.    

The key changes based on the guidance are related to lessee accounting and specifically related to operating leases. Instead of debiting expense and crediting cash/ap as payments are made related to an operating lease as you might have done in the past, you are required to set up an asset and liability on the balance sheet for your operating leases.  

The key components needed to calculate your day 1 lease liability are your lease term, discount rate and lease payments. There are a number of considerations that go into determining each but at a high level the Day 1 Lease Liability will be based on the present value of your remaining lease payments over the remaining term.  

In general, the Day 1 Lease Liability will generally equal your day 1 ROU Asset except for certain potential adjustments, such as prepaid lease payments minus lease incentives received or Initial direct costs incurred by the lessee. 

For an operating lease the subsequent accounting will be as follows:  

  • Expense will be recorded on a straight-line basis.  
  • The Lease Liability will be reduced by the payments but increased by the accretion of the interest.  
  • The Right of Use Asset will be amortized based on the difference between the straight-line rent calculation and the accretion of interest.   

For a finance lease (historically called a capital lease) the subsequent accounting will be as follows:  

  • Expense will be recorded as two components: 
    • Interest expense related to the accretion of the liability  
    • Amortization expense of the asset  
  • The Lease Liability will be reduced by the payments but increased by the accretion of the interest.  
  • The Right of Use Asset will be amortized on a straight-line basis  

The above distinction is important as it highlights the reason why classification is still relevant under the new standard (i.e., Operating versus finance leases) as the subsequent accounting and P&L treatment will be different.  

As mentioned, there are several other considerations that go into determining your calculation of your asset and liability. Further, some of the considerations will be dependent on your elections of certain practical expedients and accounting policy elections. However, some of the considerations to consider related to the calculations are as follows: 

  1. Lease Term 
    1. Short term policy exception 
    2. Reasonably certain renewal periods and termination options 
  2. Lease Payments 
    1. Variable versus fixed payments 
    2. Combination of lease and non-lease components 
    3. Reasonably certain termination payments 
    4. Reasonably certain purchase options 
    5. Amounts probable of being owed under residual value guarantees 
  3. Discount Rates 
    1. Determination of the applicable rate which may be: 
      1. Rate implicit in lease 
      2. Incremental borrowing rate 
      3. Risk Free Rate 

In addition to the above calculations that are new under the standard, there are additional disclosure requirements as well. With all these considerations and nuances, organizations should not wait to start this process. For calendar year end companies, the standard is effective as of January 1, 2022, for the annual period ending December 31, 2022.  

While this may seem overwhelming, Bonadio Strategic Advisory (BSA) is here to help. BSA has a team of professionals that can assist with the implementation of the standard and offers the following solutions: 

  1. Full Implementation Services 
    1. Assist the Company in identifying its population of leases, obtaining and reviewing the leases to generate journal entries, amortization tables and quantitative disclosures 
  2. Pass Through Software Solution 
    1. Bonadio has a relationship with a software provider to license the software to the Client to perform the calculation itself 
    2. Software provides clients with journal entries, amortization tables and quantitative disclosures 
  3. Hybrid solution 
    1. BSA provides technical accounting consulting on the implementation of the standard at an hourly rate 

The key takeaway is to not wait until the year end to implement. If you think you will need assistance with the implementation, please reach out to your audit contacts who will put you in touch with our BSA experts.  

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.