If there’s one thing for certain, accounting staff members at businesses and nonprofits have more than a few questions about the new lease standard that’s about to take effect. Implementing the biggest new accounting rule to come our way in decades is no walk in the park. That’s why we’re answering 15 frequently asked questions about the new lease standard.
Remind Me, What Is the New Lease Standard?
As a reminder, ASC 842 impacts any business or nonprofit with GAAP financial statements and at least one lease. This new lease standard takes effect for fiscal years beginning after December 15, 2021, meaning calendar year-end businesses and nonprofits will see substantial changes on their financial statements for the year-ended December 31, 2022. Businesses and nonprofits operating on a fiscal year-end will see changes in year-end 2023.
I’m an Accountant. What Are Some Things I Should be Thinking About?
At our past webinar, The New Lease Standard: What Accounting Staff Need to Know, attendees asked many questions about how to treat leases under ASC 842.
Members of Gross Mendelsohn’s audit and accounting department did a great job answering those questions during the webinar. If you haven’t had a chance to watch the recording (psst, it’s below!), no worries. Following are some of those questions that you might also have, along with our answers.
1. Can I simply change all my leases to month to month and avoid this lease standard?
No, the FASB has stated that leases should be evaluated for substance over form. If you do not expect to turn over the leased asset within the next year, it should be recorded on the balance sheet. Companies are required to make a “reasonably certain” assessment when determining the length of the contract.
2. Does the new lease standard impact all GAAP financial statements or only financials that receive an audit?
This is effective for all GAAP financials statements including compiled financials, reviewed financials and audited financials. The new lease standard does not impact companies with modified cash financial statements or income tax basis financials, or companies that do not prepare financials and only have a tax return.
3. Why did the accounting profession decide to create this standard?
This new lease standard is intended to increase transparency for financial statement users. Instead of disclosing leasing arrangements in the financial statement footnotes, the user will now be able to see both operating and capital leases on the face of the financial statements.
4. Will companies need to reevaluate existing leases under the new standard, or is this standard only for new leases?
Existing leases will still have to be re-evaluated under the new standard and an asset and liability will need to be recorded. However, companies only need to record the net present value of the remaining payments as of implementation date. Companies are given the option. You will not have to restate your 2021 or fiscal year 2022 financial statements if you elect the single-year method.
5. Do you recommend that companies use a lease management tool? Do you have recommendations for lease management tool?
If you just have one lease, you can probably just track it in Excel. However, if you have multiple leases, you should consider using a lease management tool. Otherwise, it will be time consuming and tedious for you staff to track your leases in Excel. Excel schedules are also prone to error.
After researching several lease management tools on the market, one of our favorites is NetLease. You can read more about NetLease — and features to look for in whichever lease accounting software you consider — in our blog post, Lease Accounting Software Options.
6. Who is responsible for making the entries under the new lease standard — the auditors or the organization?
It is the responsibility of the organization’s management to make this entry. However, we recommend consulting with your CPA firm for assistance if needed.
This question also brings to light a huge benefit of using a lease software tool. Lease software will give you the journal entries once you input your leases and the terms. You can then make these journal entries at year end before providing the final trial balance.
7. As rates are changing significantly this year, are there mark to market implications annually as risk-free rates are changing, or does the initial rate that I used stay in place for the entire period of the lease?
You will utilize the risk-free rate as of the initial signing of the lease or the transition date to ASC 842. The rate will not be adjusted annually even if the rate changes significantly.
8. What the best source to find the risk-free treasury rates as of certain dates?
The best place to find risk-free Treasury rates is on the U.S. Department of the Treasury’s website.
9. How are audit professionals handling materiality levels for very small leases, such as a water coolers or coffee machines? Do small leases like these really matter for a company that have revenues in the millions, when the costs attributable to these items might only be around $2,000 per year?
In audits, materiality is calculated typically based on an organization’s revenues or assets with some benchmarks. Whatever is determined to be the materiality threshold for an organization is what determines whether a lease is material enough to disclose on the financial statements. We recommend consulting with your CPA firm to determine which leases are considered material.
10. If I sign a lease in December 2022 that does not start until September 2023, do I include ASC 842 accounting on my December 31, 2022 financials?
On the lease commencement date, a lessee is required to measure and record a lease liability equal to the present value of the remaining lease payments.
11. What do we do with a building lease with $1/year payments?
Below-market lease contracts under ASC 842 should only record actual lease payments made excluding the fair market value.
12. What about a nonprofit that has donated rent?
The new lease standard defines a lease as a contract that conveys the right to control the use of an identified asset to a customer for a period of time in exchange for consideration. Because no consideration is exchanged for the use of the space, the donated space does not meet the definition of a lease under ASC 842.
13. Are related-party leases exempt from this standard?
Related-party leases are not exempt from ASC 842.
14. What needs to be done on the lessor side?
Lessors, such as landlords, will now have to separate non-lease components such as revenue for cleaning, maintenance and security services, etc. from rental revenue. Lessors need to account for these non-lease components under the ASC 606 revenue recognition standard as opposed to including them with the lease and accounting for them under ASC 842.
Lessor accounting largely remains unchanged. Lessors still classify a lease as one of the following three types: sales-type lease, direct financing and operating lease.
15. If we sublease parts of our office, do we need to adjust the ROU asset/liability or simply recognize sublease income?
Under a sublease, an entity is both a lessee and a lessor for the same underlying asset. This entity is referred to as the intermediate lessor or sublessor. The intermediate lessor is required to separately account for the original lease and the sublease unless it is released of its primarily obligation under the original lease.
How Can I Learn More About Implementing the New Lease Standard?
You can watch our 45-minute webinar for accounting staff members below. The webinar includes:
- Guidance on how to implement the new standard
- Explanations of how the new standard affects financial statements
- Walk-throughs of real-life lease scenarios and sample financial statements
- Examples of calculations and journal entries
- A robust rapid-fire Q&A session
If you’re still craving more info, check out our blog, New Lease Standard to Impact Any Business or Nonprofit With a Lease, for additional insight on this accounting standard.
Need Help?
Contact us here or call 800.899.4623.
