Accounting for Leases in 2022

Many organizations enter into lease agreements throughout the course of business. It’s an important activity that provides the organization with access to assets without the greater risks involved in owning these underlying assets.

There are two types of leases: operating leases and capital leases. The main difference between them is the transfer of ownership rights. Capital leases offer the right to own the asset at the end of the lease, while operating leases don’t. A lease for office space, for example, is typically operating. It’s signed for a period and vacated at the end of that period. A lease for a copy machine is typically a capital lease. There is often an option to purchase it at the end of the lease.

Under the current Generally Accepted Accounting Principles (GAAP) rule, only capital leases are recorded in the books as assets and liabilities. The assets are then depreciated. The lease payments for operating leases are simply treated as expenses. The new standard, ASC 842, requires that ALL leases written for a period over 12 months be recorded in the balance sheet. It’s effective for most organizations with a fiscal year beginning after December 15, 2021. The early application of this standard is permitted. Public companies and not-for-profit companies that issue or are conduit bond obligors for publicly traded securities have an effective date for fiscal years beginning after December 15, 2018.

This new standard offers the most significant benefits of comparability. Users of the financial statements can see the assets and liabilities that were previously missing from the balance sheet and compare these statements to other organizations that own their assets. The table below summarizes the benefits of ASC 842 and the implementation costs involved (Understanding Costs and Benefits- ASU: Leases (Topic 842), 2016). There are no other major costs involved with the implementation other than the time required to review all the operating leases under agreement.

Overview of Costs and Benefits of the New Leases Standard

It’s important to mention that recording leases with a term of 12 months or less on the balance sheet is optional. An organization is allowed to make an election not to recognize short-term leases. The accounting policies will need to be updated to reflect this decision. When such an election is made, the lease expense should be recorded on a straight-line basis over the lease term.

The two types of leases remain the same under the new standard. There aren’t any significant changes to the measurement, but there are a few differences in the presentation of a lease in a financial report.

For capital leases, it’s required to do the following:

• On the balance sheet, recognize an asset and liability for the asset leased at the present value of the lease payments
• On the profit and loss statement, calculate interest on the lease liability separately from the amortization of the asset
• On the cash flow statement, classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability within operating activities.

For operating leases, it’s required to do the following:

• On the balance sheet, recognize an asset and liability for the asset leased at the present value of the lease payments
• On the profit and loss statement, record a single lease cost which is generally calculated on a straight-line basis over the lease term
• On the cash flow statement, classify all cash payments within operating activities.

If you’re interested in reviewing your lease agreements, we can help. Insource provides support for identifying your type of lease agreement, and we can record it based on the new standards. For more information, email us at insource@insourceservices.com, or call (781) 235-1490.

References

Understanding Costs and Benefits- ASU: Leases (Topic 842). (2016, February 25).

Retrieved from FASB.ORG