Chris Carmen / July 13, 2022
Do you lease office space for your business or own a building that leases space to tenants? If so, you will need to get up to speed on ASC 842 sooner rather than later. The new lease accounting standard, ASC 842, is aimed to increase the transparency of financial information through the recognition of lease assets and lease liabilities on the balance sheet. The new lease standard is now a requirement for all non-public companies and will affect your 2022 financial reporting.
- THE PAST – most non-public companies utilized operating leases and would expense lease payments on a monthly basis. Often, companies would not represent lease assets or liabilities on their balance sheet.
- THE FUTURE – with ASC 842, companies will be required to capture on the balance sheet a “Right of Use” asset for all leases with a corresponding “Lease Liability”
- A manufacturing company leases a warehouse for $10,000 / month and has 5 years left on the lease. ASC 842 now will require this company to show an asset on their balance sheet equal to the value of the entire lease term (discounted by an incremental borrowing rate, let’s ignore this piece for now).
- The value of the $10,000 / month for 5 years equates to a total “Right of Use” Asset of $600,000
- The corresponding liability will be the same amount of $600,000, which is what the manufacturing company will owe to the landlord
- As the lease payments are made each month, you will amortize the Right of Use asset and lower the Lease Liability on the balance sheet
Why it Matters
- For most small to mid-size companies with de minimis lease contracts, this will likely not be a meaningful impact on your day-to-day operations outside of making sure your accounting team has appropriately adopted the new changes
- However, for some companies that are highly dependent upon leasing buildings, equipment, or vehicles – there may be a greater impact. Some common examples below to be on the lookout for:
- Debt covenant ratios for credit facilities could be negatively impacted. Make sure the new covenants either carve out the ASC 842 implications or the covenants factor it into the ratio requirements
- Internal KPIs or company metrics can be drastically impacted – make sure your teams know how to adjust
- Please note: this is a simplified version of the new lease standard requirements and business owners should consult with their respective accountants and other professional advisors to fully understand how this will impact their company.
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