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New Lease Accounting Standard Checklist (for lessee accounting)

September 20th, 2022 • Blog

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Deborah Tarbox, CPA, CCA, CGMA

The Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2016-02 (Topic 842, Leases) changes the manner in which companies and nonprofits will account for and disclose leases. The new standard applies to lessees and lessors reporting using accounting principles generally accepted in the United States of America (US GAAP) and brings significant changes to the entity’s balance sheet. Public companies who adopted the new lease standard already found that it took longer and required more effort than originally anticipated. Non-public companies and nonprofits should consider the additional time and the size of the task, which will require more work, more resources, and more time than most entities realize. For non-public business entities and nonprofits, ASC 842, Leases, is effective for fiscal years beginning after December 15, 2021 (effectively 2022 for calendar-year-end entities).

Melanson has developed this checklist as a tool to help you get started and walk you through key steps in the implementation process. Before getting started you will want to educate your accounting team about the new standard and understand its implications for your organization.

Step 1: Identify Your Lease Population
  • Understand the new definition of a lease –
    • For a contract to be or include a lease, there must be an identified asset and the contract must grant to the customer both (a) the right to obtain substantially all of the economic benefits of the asset’s use and (b) the right to direct the use of the identified asset throughout the period of use.
  • Review recurring expenses to look for lease payments
  • Review general ledger accounts with key words that could indicate a lease (for example rent, lease, subscription, contractor)
  • Leases may include office space rental, vehicles, equipment, office equipment, and embedded leases (equipment or other assets included in a service contract)
  • Review your contracts (not only lease contracts) and other agreements to identify previously unknown leases – which may include embedded or in substance leases
  • Consider information from all business locations
  • Identify your lease population
  • Document your procedures performed to identify your lease population

Step 2: Create an Inventory of Leases

  • Review all data in all contracts identified in Step 1
  • Using the ASC 842 Lease Decision Flowchart, determine contracts containing a lease
    • See flowchart below
  • Exclude certain contracts that do not fall under the new lease standard, such as intangible assets like SAAS software, inventory, and assets under construction
  • From the identified lease contracts, compile a listing of your total lease population, including significant lease terms such as the following:
    • Key dates – for example, commencement and termination
    • Lease term – including early termination and renewal provisions, and options to renew or cancel
    • Asset details including type, description, and location
    • Payment terms including termination penalties, purchase options, renewal term payments, and residual value guarantees
    • Lease incentives and initial direct costs
    • Variable lease payments tied to sales or an index which require special treatment:
      • Variable payments tied to sales are expensed.
      • If payments are tied to an index, organizations following ASC 842 use the index at the lease start date or initial application date (whichever is later) to calculate the lease payments. Changes in the index are expensed.
    • Determine useful life of the asset to determine amortization period
  • Document procedures performed to create your inventory of leases

Step 3: Evaluate Existing Lease Business Processes

  • Identify who is responsible
  • Consider whether current resources are sufficient
  • Identify areas other than Accounting that are involved in the existing lease business processes (Procurement, Legal, Treasury)
  • Determine if lease processing and record retention are centralized or decentralized

Step 4: Assess Current Systems and Use of Technology for Lease Processing

  • Identify current spreadsheets and/or manual tracking being used
  • Determine what separate lease accounting software (not part of ERP, General Ledger) is in place, if any
  • Review the accounting software to determine if all of the required general ledger accounts are included. This includes ROU Assets, Short-Term Lease Liabilities, Long-Term Lease Liabilities, Operating Lease Expense, Variable Lease Expense, Short-Term Lease Expense, and Finance Lease Expenses like Amortization Expense and Interest Expense
  • Determine if there is a lease module in your ERP and if it has future capabilities

Step 5: Technical Analysis and Assessment

  • With your full lease population in mind, determine your accounting policy elections and practical expedients, including non-lease components, short-term leases, leasehold improvements, and lease accounting during the transition period
  • Determine the process for classification criteria, including the fair market value and economic life of the lease asset
  • Determine how discount rates will be determined and applied (ASC 842, Leases, does provide a policy election to use the risk-free rate)
  • Decide on one of the available transition methods and consider discussing these approaches with your financial statement users, stakeholders, and peer organizations, if relevant
    • Modified Retrospective Type 1: Under this approach, you are adopting the new lease accounting standards as of the earliest period presented in your financial statements.
    • Modified Retrospective Type 2 (Effective Date Method): Using this method, you will adopt the new lease accounting standards on the effective date. Your balance sheet and prior period disclosures will show accounting based on the old standard applied to the previous years.
  • Assess whether your organization’s existing systems, internal controls, and processes are adequate or if new systems and tools are required

Step 6: Update and Finalize Lease Accounting Policies and Processes

  • Determine lease accounting software solution policies, if applicable:
    • Name the administrators
    • Establish role-based and location-based accesses
    • Define input, change, and approval thresholds
  • Establish review and approval for:
    • New leases
    • Subsequent lease activities, i.e. modifications and terminations
  • Develop and document control and output testing procedures
  • Draft a lease accounting policy white paper outlining your policy elections and practical expedients, and how they impact your financial statements
  • Discuss lease policy decisions with your auditor

Step 7: Lease Calculations

  • If your assessment has determined that lease accounting software will be necessary for your implementation, then review your vendor options, finalize software selection, and start the set-up process
  • If using a lease accounting software solution, train the users/reviewers
  • Consider creating and distributing a template to all departments and locations to capture lease data
  • Using data from your total lease population, upload lease details into lease accounting software, or run calculations to determine appropriate entries
  • Consider business process changes that need to be made for the organization’s internal control environment around data entry, authority to enter contracts, and review

Step 8: Data Validation

  • Run a manual test on a population of leases to ensure technology and software systems are accurate
  • Run applicable historical transactions through new systems and business processes to calculate the effect on prior periods or the cumulative effect upon adoption date
  • Allow time for your auditor to test your restated accounts or cumulative adjustment
  • Prepare new disclosures and ensure auditor concurrence

Step 9: Record ASC 842 Transition Entries

  • Determine interest rates at transition date
  • Create new General Ledger accounts as needed
  • Generate/calculate transition entries
  • Generate/calculate data for new financial statement disclosures

Step 10: Subsequent Accounting

  • Update/document processes for:
    • Additional leases
    • Lease modifications
    • Generating month-end closing entries
    • Generating year-end closing entries, if needed

While the new lease accounting standard will probably require significant time and effort to implement, you may identify benefits in addition to compliance. You may identify unused leases, helping to free up cash. Lease data analysis may provide insight to improve lease negotiations in the future. You could gain deeper insight into leasing costs to assist you in making better decisions.

The clock is ticking towards implementation of the new lease accounting standard. Do not underestimate the effort and time required to adapt to this complex set of lease accounting changes.

Regardless of where you are in the process of implementing the new lease accounting standard, the professionals at Melanson are here to help. Please contact us today to set up a consultation.

 

HELPFUL LINK: FASB Lease Information

Excerpt from: FASB Accounting Standard Codification, 842-10-55-1, Leases, Overall, Implementation Guidance and Illustrations, Identifying a Lease

The following flowchart depicts the decision process to follow in identifying whether a contract is or contains a lease. The flowchart does not include all of the guidance on identifying a lease in this Subtopic and is not intended as a substitute for the guidance on identifying a lease in this subtopic.

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