Have You Forgotten About the New Lease Standard?Effective Date for Non-Public Business Entities for Fiscal Years Beginning after December 15, 2021

8/9/2021 - By Bill Massey, CPA and Joshua Jackson, CPA

I am sure you remember that in February 2016, the Financial Accounting Standards Board (“FASB” or “the Board”) issued its highly-anticipated leasing standard in Accounting Standards Update (ASU) 2016-02 (“ASC 842” or “the new standard”) for both lessees and lessors.

The new standard was supposed to be effective for non-public entities for fiscal years beginning after December 31, 2019. However, in June 2020, the FASB postponed the new lease standard implementation date for non-public companies to fiscal years starting after December 15, 2021, after a 2019 decision to delay the effective date, as well.

Impact on Lease Accounting

Under the new ASU, a lessee will recognize right-of-use (ROU) assets and related lease liabilities on the balance sheet for most leases based on the present value of the future lease payments. The ASU applies to both operating and finance leases, but the pattern of expense recognition in the income statement depends on a lease’s classification. For operating leases, the lessee would recognize lease expense on a straight-line basis over the lease term. For a finance lease, the lessee would recognize both interest expense and amortization or lease expense. The new standard will also require additional disclosures regarding lease contracts.

Lessor accounting remains largely consistent with previous U.S. GAAP but has been updated for consistency with the new lessee accounting model and with the new revenue standard: ASU 2014-09.

What to Do Now

In advance of the effective date, you need to identify all leases and related documents for evaluation. In some cases, this might include a review of service contracts for embedded leases. Once all relevant documentation is gathered, we encourage clients to begin the conversation about the potential impact of adoption on their balance sheet and other potential impacts of implementation, including potential effects on debt covenants.

Transition Methods

The new standard provides for two transition methods – the modified retrospective approach and the new transition alternative. The new transition alternative generally changes when an entity initially applies the new standard (e.g., when an entity initially recognizes operating leases on balance sheet). However, it does not change how an entity initially applies the new standard. For example, the guidance about how an entity initially measures existing operating leases is the same regardless of whether the modified transition approach or the new transition alternative is elected.

Modified Retrospective

The new standard initially included a single transition method which we will refer to as the modified retrospective approach. Under that transition method, an entity applies ASC 842 retrospectively to each prior reporting period, subject to specific practical expedients and transition requirements. Therefore, an entity that is a lessee must recognize operating leases on balance sheet at the later of the beginning of the earliest comparative period presented in the financial statements and the commencement date of the lease (this later of two dates is the date of initial application under this transition method). The recognition requirement applies to all existing operating leases, including leases that expired before the adoption date. An entity (lessee or lessor) must also provide the new and enhanced disclosures in all periods presented, including the prior periods. The effect of adopting the new standard is recognized as a cumulative effect adjustment to retained earnings at the beginning of the earliest period presented.

New Transition Alternative

In July 2018, the FASB issued ASU 2018-11, which provides entities with an additional (and optional) transition method with which to adopt the new standard (referred to as the new transition alternative). Under the new transition alternative, an entity initially applies the new standard to all leases existing at the adoption date (the date of initial application under this transition method) and recognizes a cumulative effect adjustment to the opening balance of retained earnings at that date. This means that the comparative periods presented in the financial statements remain under the legacy leases guidance (ASC 840). If an entity elects this new transition alternative, it is required to provide the ASC 840 disclosures for all prior periods presented that remain under the legacy leases guidance. The FASB provided this additional transition method to reduce costs and complexity for preparers in implementing the new standard.

Observation: Given the significant cost relief provided by the new transition alternative, we expect most non-public business entities will adopt the new standard using that transition method rather than the modified retrospective approach.

Questions?

For any questions and more information on the new lease standard, reach out to our Financial Institution Advisory Group!

About the Authors | Bill Massey, CPA and Joshua Jackson, CPA

Bill is a shareholder in the Financial Institution Advisory Group of Saltmarsh, Cleaveland & Gund. Since joining Saltmarsh in 1990, Bill has worked primarily with financial institution clients where he was developed extensive knowledge of accounting, tax, and regulatory issues that affect financial institutions. His specialized financial institution experience includes loan and credit quality reviews, internal audit, internal control reviews and assessments, mergers and acquisitions, and due diligence services.

Josh is a senior manager in the Financial Institution Advisory Group of Saltmarsh, Cleaveland & Gund. He has over 18 years of public accounting and financial services experience, primarily serving financial institutions. Josh has extensive experience in delivering accounting services, external audits, directors’ examinations and agreed-upon procedures, loan and credit quality reviews, internal audits, due diligence projects related to mergers and acquisitions, and other consulting services.