If your organization deals with leases, your team needs a good grasp of the new lease accounting standard that is relevant to you. While the deadlines for IFRS 16 and GASB 87 compliance are already past, ASC 842 for private companies and not-for-profit organizations is imminent. But how do you know if your company needs to update its procedures to comply with these standards before January 1, 2022?
For a little background history, many prominent businesses leveraged loopholes in the old standards to structure their lease agreements to keep them off the balance sheet and skew the financial ratios in a more favorable direction. Because there was an ongoing series of disclosures of fraudulent reporting by these major companies, the SEC sent a letter to IASB and FASB asking them to develop standards that accurately reflect a company’s true liabilities. Now, companies are responsible for providing reports on their cash flows, profit-making opportunities and overall financial conditions. Answering these four questions, you can determine what steps you need to take.
1. Do you get a financial statement audit?
In a financial statement audit, auditors examine the business’s financial records for your company. Auditors ensure all the elements of the financial statements are accurate, complete and presented in fairness. The purpose of the financial statement is to add credibility to the reported financial position and performance of the business.
Federal securities laws require publicly held companies that file reports with the SEC to submit financial statements that are accurate, truthful and complete. Many of these financial statements - including those in the company's annual report and those provided to shareholders in connection with the solicitation of proxies for annual meetings - must be examined and reported on by an independent auditor.
Private companies are regulated to have an audit every year as part of communication with the shareholders. An audit provides the public with additional assurance — beyond managements' own assertions — that a company's financial statements can be relied upon. Does your company get a financial statement audit? If you do, continue to the next question.
2. Are you a public or private company running GAAP, IFRS, or GASB financials?
The accounting standards developed and established by the Financial Accounting Foundation’s (FAF) standard-setting Boards—the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB)—determine how those financial statements are prepared. The standards are known collectively as Generally Accepted Accounting Principles—or GAAP.
Audits have become more common as the complexity of the two primary accounting frameworks, Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) has increased.
GAAP requires three financial statements: the income statement, the balance sheet, and the cash flow statement. IFRS requires a complete set of financial statements at least annually: financial position, profit, and loss, changes in equity, statement of cash flow, a summary of significant accounting policies and statement of financial position. GASB establishes accounting and financial reporting standards for the U.S. state and local government agencies that follow GAAP.
Because these lease standards have changed and the new deadline is approaching January 1, 2022, if you run any of these financials, you need to comply with ASC 842.
3. Do you have one or more leased assets, including embedded leases?
Perhaps you have a financing lease or a capital lease. Maybe you lease your office, warehouse space, vehicle fleet, computers, copier or other types of equipment. The new standards now require virtually all leases to be reflected on the balance sheet. A “lease liability” is recorded at the start of the lease, and a new “right of use” (ROU) asset account is introduced for all lease types.
Whether your contract includes the term “lease” or not, it is considered a lease if it conveys the right to control the use of the asset, over a period, for consideration. Many companies have contracts that contain embedded leases. Look closely and work with all operational departments to understand the contracts and assess your level of risk by answering these questions:
- Do you contract with third parties to manufacture products?
- Is your company subject to regulations that may require dedicated equipment?
- Do you lease property that includes a maintenance contract?
Look at your contracts and evaluate the wording to help review and identify if you are in a lease agreement.
4. Do your lease terms exceed one year?
With the new FASB rule, all leases of 12 months and longer must be recognized on your balance sheet. To be classified as an operating lease, the lease must meet certain requirements under generally accepted accounting principles (GAAP) that exempt it from being recorded as a capital lease. Companies must test for four criteria—known as the “bright line” test—that determine whether rental contracts are booked as operating or capital leases. Whether a capital lease or an operating lease, if the terms are longer than one year, you will need to follow the new standards. Certain contracts that were not previously thought of as leases will begin receiving lease accounting treatment in the future to comply with the new lease standards.
The Bottom Line:
If you answered yes to any of the above questions, you will need to comply with the new leasing standards that take effect on January 1, 2022. If you use NetSuite for your accounting purposes, you can use NetLease to streamline and simplify your process. Ask for a demonstration, using the link at the bottom of the page, and one of our team members will reach out to you to schedule a time.