25 April 2022
The Financial Accounting Standards Board’s (FASB) standard on lease accounting (ASC 842) will be effective for non-public companies for their fiscal years beginning after December 15, 2021. For the vast majority of automotive retailers, the standard is effective for the December 31, 2022 year-end. Prior to ASC 842, only finance leases (formerly referred to as “capital leases”) were recognized on a lessee’s balance sheet; while operating leases were limited to disclosures contained in the notes to the financial statements. Under ASC 842, generally all leases with terms greater than 12 months are now required to be recognized on the lessee’s balance sheet as a right of use asset as well as a corresponding lease liability.
What may sound like a little more than an accounting or clerical nuisance, ASC 842 has the potential to cause some serious headaches and delays when working on closing out and completing the December 31, 2022 year-end financial statements. The time commitment required to identify and evaluate potential lease agreements can accumulate quickly. This additional commitment, along with the normal rush during year-end, has the potential to disrupt and delay the audited, reviewed, and/or compiled financial statements issued by CPA firms. Taking action over the next 3-9 months will pay dividends a year from now and help to ensure that the 2022 financial statements are issued and available by their established deadlines with lending institutions, investors, and other users.
The first phase is to address the following:
- Do you have a listing of all of your lease agreements complete with their pertinent information
- Lease term (complete with renewal options)
- Total of all payments made prior to the lease commencement
- Remaining amount and number of payments including any variable payments
- Interest rate on each lease (if borrowing rate is not stated)
- Embedded contract leases (example – IT service contract with a hardware component)
- Related party leases – what are the legally enforceable terms and conditions?
- Any tenant at will agreements should be evaluated based on enforceable rights and if they are reasonably certain to continue to occur
- If information has not yet been gathered:
- Decide who is going to be responsible for evaluating and compiling this information?
- Determine if this task will be completed internally or will you need assistance from an outside professional
- Find the easiest way to identify any potential leases (evaluating recurring payments, reviewing related party activities, review of potential purchase agreements currently being discussed/negotiated)
- If completing internally, determine if your business going to calculate the right of use asset and lease liability or if you will rely on an outside professional. If calculating internally, consider purchasing software to assist in this calculation.
- Determine what the impact of the newly recognized lease liability will be on any debt covenants and ratios and if your debt agreements cover this topic.
After the above items are addressed or in process, it is important to establish and maintain a timeline for this project with realistic goals. This timeline should be generated with the understanding that it may take longer to obtain the relevant information from lessors or to address debt covenant ratios with lending institutions due to the anticipated high level of demand from lessees and limited personnel resources due to the current level of turnover in the job market.
Developing a plan now or in the near future to address ASC 842 will help to limit the disruption of implementing this new standard.