After some delays, the new lease standard (ASC 842) is now effective starting from year 2022 for all nonpublic companies and non-profit organizations. However, this does not apply if the companies use cash basis of accounting.
There are significant changes under the new lease standard, of which the most important one is that all leases or rents with term more than 12 months must be capitalized and presented on the Balance Sheet as lease liabilities and assets. After that, the business has to amortize the lease liabilities/assets over the term of the lease. This is a complicated and time-consuming task that is prone to errors. So it is recommended that you discuss with your CPA before starting the process.
The current lease standard is quite simple: you can only capitalize a lease if it meets certain criteria. For most of operating leases, e.g. lease of office, you do not need to capitalize the lease. But now under the new standard, any leases with term more than 12 months will be capitalized.
The new lease standard will have significant impact on the financial statements of many entities because most operating leases will now be capitalized and reported as asset and liability on the balance sheet. This will increase the entities’ liabilities and consequently has adverse impact on certain financial ratios, especially when the entities have loans and have to maintain good financial ratios in order to satisfy loan covenants.
To understand the new lease standard in details and better prepare for changes and effect caused by the new standard, the management should now contact and work with accounting experts, who will help review the entity’s current and future leases and work out solutions to minimize any possible adverse impact on the business and financial statements of the entity.