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Adoption of ASC: 842 New Lease Accounting Standard

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Adoption of ASC

Accounting Standards Codification Topic 842 is the new lease accounting standard published by the Financial Accounting Standards Board (FASB). ASC 842 replaced the previous US GAAP leasing standard i.e. ASC 840 which is almost 40 years old, after December 15, 2018 for fiscal years and interim periods for public companies. Currently, for calendar-year private companies, the effective date for ASC 842 is January 1, 2020 and for interim periods after December 15, 2020.

The purpose of the new lease accounting standard is to require organizations that lease assets to disclose the assets and liabilities of their leases on the balance sheet whereas the previous lease accounting standard (ASC 840) reported operating leases as expenses with some disclosure in the footnotes of financial statements.

ASC 842 also classifies leases into two groups: operating leases and finance (capital) leases and leases lasting more than 12 months must be reported on the balance sheet.  However, ASC 842 standard also requires qualitative and quantitative disclosures on timing, amount and unpredictable cash flows that arise from leases.

Criteria for a Contract to qualify as a lease

  • Identified asset: To qualify as identified asset, Asset is explicitly or implicitly specified in the contract, Asset is physically distinct, and supplier does not have a substantive substitution right.
  • Economic benefit: The lessee must obtain substantially all economic benefits from use of asset.
  • Direct use of asset: The lessee must have the right to direct the use of asset and right to operate the asset.

Calculating the asset and liability

  • Right-of-use asset: The right-of-use asset is valued as the initial amount of the lease liability plus any initial direct costs and lease payments made prior to the commencement date, and minus lease incentives.
  • Lease liability: The lease liability is calculated as present value of the lease payments, using the discount rate specified in the lease, or if that is not available, the company’s incremental borrowing rate (IBR).

Five Step Process under ASC 842
There is a five-step process to tackling ASC 842’s time-consuming calculation and reporting requirements:

  • Step 1: Build a Cross-Functional Team
    ASC 842 touches the entire organization. Therefore, the ASC 842 team should reflect the many functions that are impacted, such as IT, legal, procurement, accounting, treasury, and possibly others.
  • Step 2: Collect and Organize Contracts
    Remember to collect all Contracts/Agreements, including master lease agreements. Again, technology will be a critical role in keeping these key documents in one place saving precious time and ultimately money.
  • Step 3: Ascertain Whether the Contract is or Contains a Lease
    Each contract will need to be analyzed to Ascertain whether the contract contains/includes a lease for ASC 842 purposes. Companies should be on lookout for embedded leases. Contracts that include the outsourcing of services and arrangements involving data centers, hosting and other IT arrangements are common examples of embedded leases.
  • Step 4: Capture Lease Data
    A lease contains / includes many data elements that are required for ASC 842 calculation purposes.
  • Step 5: Automate with Software
    In the case of ASC 842, companies in many cases have no previous process and are starting from scratch. Advanced leased asset systems provide you with rules engines and web services (API’s) to export, transform, and load data.

Impact to the balance sheet
There will be an increase in assets and liabilities on the balance sheet. Under ASC 840, capital leases were recorded in company’s balance sheet, but operating leases were not and under ASC 842, both classifications of leases, operating and finance, will be capitalized on the balance sheet. There are a few exceptions, such as certain short-term leases less than or equal to 12 months in duration. However, in most cases a right-of-use (ROU) asset will be recognized on the balance sheet along with a corresponding liability for the lease obligation.

Impact to the income statement
The treatment of finance and operating leases will differ on the income statement under the new ASC 842 standard. For finance leases, the interest and amortization of the lease are presented separately on the income statement. However, for operating leases, the two are combined into a single line item. For operating leases, a straight-line expense profile typically results. For finance leases, the expense profile is typically front-loaded due to the separate interest on the lease liability.

COVID-19’s impact on lease accounting
As a result of the COVID-19 pandemic, there may be various accounting and financial reporting considerations introduced by the FASB’s new lease accounting standard (ASC 842). Certain of these considerations include:

  • Accounting for rent concessions, rent forgiveness, and/or rent deferral;
  • Impairment of Right of Use Assets;
  • Requirements of lease modification;
  • Determining key assumptions in measuring the lease e.g. discount rate; and
  • Take account of certain transactions that may result from business interruption e.g. sale and leaseback transactions.

Here at AJSH, we assist our clients in bookkeeping, payroll, auditing, taxation, secretarial compliances, and preparation of financial statements keeping in mind all the compliances. If you have any questions or require any assistance in this regard, kindly contact us.

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