5 Tips for Implementing the Lease Accounting Standard
Information is from the AICPA. Click here for full article.
When implementing the standard, private company CPAs should consider the following:
1. Companies will be required to record a lease liability and a right-of-use asset for all operating leases. Finance leases (previously referred to as capital leases) will continue to be recognized by lessees on the balance sheet. The new guidance is not expected to have any significant impact on the income statement or cash flow statement.
2. A lease exists when there is an identified asset and a company using that asset has the right to control the asset. A critical activity in implementing the standard is identifying all existing leasing arrangements. This includes analyzing all contracts, not just those that are papered as lease contracts. Leases exist in other contracts such as service contracts where the right to use an asset is “embedded” in the contract. Short-term leases (less than 12 months) do not have to be recognized on the balance sheet. However, disclosure of short-term lease costs is required for all periods presented in the financial statements.
3. Similar to the new revenue guidance, a lessee must determine whether separate components of a contract exist (lease and nonlease). If so, the consideration in the contract must be allocated between the separate components. Lease components are accounted for within the leasing guidance while nonlease components are accounted for within other applicable GAAP. However, a shortcut for lessees exists where they can account for the entire arrangement in accordance with the leasing guidance in certain circumstances.
4. A key area for consideration when measuring lease assets and liabilities is the lease term, which includes the consideration of renewal options in certain circumstances. Companies must also determine the appropriate rate to discount the lease payments. Generally, a lessee will use its incremental borrowing rate, which is a collateralized rate. Private companies and not-for-profit organizations may use the risk-free rate as a shortcut.
5. Other important guidance to consider relates to how to account for modifications and impairment of lease assets. Companies must comply with new detailed disclosure requirements. Additionally, it’s imperative to understand the transition requirements to ensure that lease assets and liabilities get recognized upon a company’s adoption of the standard.