Yes, a significant change will be appearing on your financial statements if you have operating leases. Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 842, Leases, is effective for private companies and nonprofit organizations annual reporting periods beginning after December 15, 2021. For most of us, this change will impact the financial statements dated December 31, 2022 or later. The main objective of the standard is to improve financial reporting by enhancing transparency of leasing obligations; in particular, operating lease contracts. Per ASC 842, a lease is a contract granting control of an identifiable asset for a specific period in exchange for payment. For example, if you lease a building or vehicle, then you have an asset that needs to be identified as an asset over the length of the lease. Finance leases, also known as leases that include the purchase of the item leased, have previously been, and will continue to be, required to be recorded on the balance sheet. Operating leases have been treated as off balance sheet transactions; which means, they were not recorded on the balance sheet. However the payment obligation of the lease contract is a liability to your organization and isn’t shown as something you owe on your balance sheet. After adoption of the standard, operating leases will be recorded on the balance sheet as well. A lease will be recorded on the balance sheet as a right-of-use (ROU) asset and lease liability. The lease liability is the payment obligation over the term of the lease contract, while the ROU asset represents the control of the asset under the lease contract. The asset and liability of operating leases need to be presented separately from finance leases, either on the face of the balance sheet or in the notes to the financial statements. For example, let’s look at a building lease, the asset will be the building and the liability will be the lease payments, both shown on your balance sheet. The ROU asset, the building in our example, is amortized over the term of the lease and, unless the initial term of the lease is twelve months or less, will be presented as a long-term asset on the balance sheet. The lease liability, the lease payments in our example, is subject to the classification between current and long-term liabilities. On the income statement, the amortization, or reduction in the value, of the ROU asset will be recognized as an expense. No change in the treatment of interest expense on finance leases.
Overall, no significant change in the presentation of finance leases. The standard impacts operating leases. Depending on the types and quantity of operating leases your organization is committed to would influence our recommendations for best practice on implementing the new lease accounting standard. For further guidance please contact ADKF and we would be glad to assist you in your preparation of the adoption of the standard.