Part 4: ASC 842 is coming. In this last of our four-part series, we will discuss financial statement disclosure associated with the new standard.
Please note, if applicable, your M&S Advisor will reach out soon to ensure the implementation of this new standard.
The New Lease Standard... Coming (really) soon!
By now, you are nearly an expert on FASB’s new accounting and reporting standard for leases – Accounting Standards Update No. 2016-02, Leases (Topic 842). This new standard will become effective for non-public business entities for fiscal years beginning after December 15, 2021. This standard requires companies to include more leases than ever on their balance sheet.
You can find all of the information from our previous three articles on our Lease Standard resource pages.
Today, we will cover our fourth and final topic, financial statement disclosures under ASC 842.
Financial Statement Disclosures
ASC 842 requires lessees and lessors to provide additional information about their leases. This includes making significant judgments on how to account for leases and the amounts to be recognized on the financial statements. The goal of the disclosures is to enable users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.
For the LESSEE
The following are some of the quantitative and qualitative disclosures that will be required for the lessee under the new lease standard.
- Information about the nature of its leases
- Maturity analysis of lease liabilities
- Lease expense, split between operating and finance leases
- Short-term lease expense
- Variable lease expense
- Sublease income
- Weighted average remaining lease term
Weighted average discount rate.
For the LESSOR
The following are some of the quantitative and qualitative disclosures that will be required for the lessor under the new lease standard.
- Information about the nature of its leases
- Maturity analysis of lease investments
- Profit or loss recognized at lease commencement (for sales-type leases)
- Lease income
Qualitative and quantitative information about significant changes in residual values of leased assets.
Additionally, the new lease standard requires companies to use a modified retrospective approach. In other words – companies not only have to do things differently in the future, but also for past comparative periods.
The new standard also provides certain “practical expedients” companies may elect at the date of transition to ease the burden of adoption. These practical expedients would permit companies to not reassess at the date of initial adoption:
- Whether any expired or existing contracts are or contain leases.
- The lease classification for any expired or existing leases. (All existing leases that were classified as operating leases in accordance with Topic 840 will be classified as operating leases and all existing leases that were classified as capital leases in accordance with Topic 840 will be classified as finance leases.)
Initial direct costs for existing leases.
A fourth practical expedient would allow an entity to use hindsight in:
- Determining the lease term when considering lessee options to extend or terminate the lease and to purchase the underlying asset; and
- Assessing ROU assets for impairment.
The first three practical expedients must be elected together (i.e., all or none). In contrast, the fourth practical expedient may be elected separately; however, if elected, it must be treated as an accounting policy election. It cannot be elected on a lease-by-lease basis.
For companies that avail themselves of the practical expedients, the primary effect of adoption will be the grossing up of the balance sheet for any existing operating leases.
YOUR first step...
ASC 842 may impact the debt and credit arrangements you have with your lenders. In fact, while the health of your business may not change – the updates to your financial statements could have a significant and negative impact on your debt ratios. In the most severe cases, this could trigger a “default” on your debt agreements.
In addition to discussing the changes with your M&S Advisor, we recommend reaching out to your lenders and banking partners to discuss how your financial information will be used and what potential impact the new standard will have.
Specially, you and your partner should:
- Review any clauses in your current agreements preventing default from the GAAP adoption
- Renegotiate loan agreements to accommodate the impact of ASC 842
- Obtain an incremental borrowing rate used to calculate the value of your lease and obligations.
We are here for you
If this process leaves you feeling a bit overwhelmed, you are not alone. The new lease standard is complex and full of circumstantial exceptions. Your M&S Advisor is here to help you understand and implement this new change!