What Private Companies Need to Know and Do About the New Lease Accounting Standard for 2022
By Wesley Veigle and Dan Ryan
After granting a yearlong delay due to COVID-19, non-public companies must adopt the new lease accounting guidelines that greatly expands the financial reporting requirements for leases.
The new standard is effective for all non-public companies for fiscal years beginning after December 15, 2021. Because of its significant impact, the work to prepare for the new lease standard needs to begin immediately.
Why the Change
The change is part of the Financial Accounting Standards Board’s (FASB) efforts to increase financial transparency by showing the full impact of leases on a company’s balance sheet. The old standard faced criticism for not requiring sufficient information about a company’s leasing transactions and allowed room for various interpretations.
In response, the FASB issued Accounting Standards Codification 842 – Leases, to address these concerns.
Effects on Your Company’s Financial Statements
In the past, only capital leases were listed on the balance sheet, and operating leases were expensed straight-line on the income statement. The new standard requires the inclusion of almost all leases, both new and existing, with terms of greater than 1 year on the balance sheet.
For private businesses, the new standard applies for all leases, including offices and warehouses, vehicles, and any other leased equipment, and these leases will now be presented on the balance sheet as a right-of-use-asset and a corresponding lease liability.
Depending on the size and quantity of your leases, the company’s overall assets and liabilities will be significantly higher than prior periods. These changes may cause headaches with existing banking covenants and agreements.
Potential Impacts with Lenders
There is a significant risk of debt covenants failing due to the new standard. The addition of new lease liabilities on your balance sheet may have a significant effect on common lending ratios such on the company’s leverage (debt to equity) and return on assets (income to assets).
While the new reporting does not change the underlying financial soundness of your company, the sudden addition of liabilities to your balance sheet may at least necessitate a conversation with lenders. It’s imperative to understand the overall effects of the new standard on your financial statements, their impact on your lending agreements, and to have these conversations with the respective parties well before the end of the year.
Gearing Up for the New Lease Accounting Standard
Compliance with the new standard is complex, time consuming and may force significant changes to systems and processes. Private companies need to choose an approach and which technology platforms they will use. The legwork for the new standard needs to start today.
Deciding how to apply and account for the new standard is complex and will take more than merely changing some lines on a spreadsheet. The new standard could add significant amounts to both sides of the balance sheet that were not there before. The changes could directly affect financial ratios related to banking covenants, and force additional analysis for future considerations regarding buying vs. leasing equipment.
The Boyer & Ritter team is equipped with the technology and skills set to help you through the implementation process and discussions with your lender.
About the Authors:
Wesley Veigle is a manager at Boyer & Ritter with experience providing tax and accounting services for closely-held businesses, especially in the construction and real estate industries.
Daniel J. Ryan is a supervisor at Boyer & Ritter and has experience working with clients in the construction and real estate industries, as well as other closely held businesses.