September 2, 2022Share:
The new lease accounting standard is effective for nonpublic organizations with fiscal years beginning after December 15, 2021, which means for most organizations with calendar year-ends, the standard is effective now. The changes to financial statement treatment of leases are significant.
All lessees must now record a Right of Use Asset and a Lease Liability on the balance sheet. Leases are classified as either “operating” or “finance” leases. Interest and amortization expense will be recognized for finance leases while only a single lease expense is recognized for operating leases, typically on a straight-line basis. Contracts must be further divided into lease and non-lease components. For each lease component certain items must be identified:
• Length term – per the new standard, defined as “the noncancellable period for which the lessee has the right to use an underlying asset”. This isn’t necessarily the stated length of the lease. The length term could also be affected by options to extend or terminate the lease, whether controlled by the lessee or the lessor, or other factors.
• Payments to be capitalized – includes noncancellable fixed payments, essentially fixed payments (i.e. minimum amounts due under a formula or other unavoidable amounts), or other payments if they are reasonably certain to occur, such as a buyout payment at lease end.
• Discount rate – varies depending on the organization’s specific situation. The discount rate could be the inherent or actual rate, the incremental borrowing rate, or the risk-free rate.
The calculations necessary to arrive at the appropriate amounts can be complex, and the new standard brings with it additional disclosure requirements as well. However, there are certain practical expedients that can be applied to make adoption in the initial year simpler.
As always, if you have questions, please reach out to our team.