While the new lease accounting requirements are effective for fiscal years beginning after December 15, 2021, businesses are not required to present financial statements in accordance with ASC 842 until annual statements for the first year under the new standard are issued. When speaking with businesses about effective dates, the realization that interim reporting during 2022 is not required to reflect ASC 842 adjustments hits management with an, “oh…,” and the renewed procrastination is audible. We know they’re thinking, “we still have another year then!”
It’s true. While the new requirements are effective for calendar year entities starting January 1, 2022, financial reporting in accordance with GAAP will not reflect the new lease accounting requirements of ASC 842 until the financial statements for the year ending December 31, 2022 are issued.
So, we do have another year then, right? We can wait until we close the books for 2022 and perform the calculations as of year-end? Sorry, but the answer is no. Further delay in implementation won’t make things easier. In fact, it may make things more complicated.
Transition is as of the beginning of the year, not the end.
ASC 842-10-65 requires that transition disclosures be made in accordance with ASC 250, Accounting Changes and Error Corrections. One of those requirements is to disclosure the cumulative effect of the change on retained earnings (or other components of equity or net assets) in the statement of financial position as of the beginning of the earliest period presented. For entities electing the effective date transition method (forgoing comparative reporting in the year of adoption), the cumulative effect disclosure is made as of the beginning of the period of adoption. As such, you’ll likely need to perform calculations as of the effective date – not as of year-end – in order to determine the amount to disclose.
Additionally, if lease activity is recorded in accordance with ASC 840 during 2022, you may need to correct misstatements in income statement activity for the year. While ASC 842 results primarily in balance sheet changes, the income statement can be impacted as well. These impacts can’t be ignored for the first year of adoption. And the longer an entity puts off implementation, the more significant these impacts could become.
As you can see, waiting until the end of the year won’t save you from having to perform calculations as of the beginning of the year, as well as for the income statement activity during the year. You would only be delaying the inevitable.
What are the risks?
- Leases with non-level payments may not be properly recognized using a straight-line lease expense. This isn’t a new concept compared to the prior guidance under ASC 840; however, there is an increased risk that this will go undetected for embedded leases until they are later identified.
- During 2022, events may occur that require a remeasurement of lease liabilities and ROU assets. These could require changes to lease payments, the discount rate used and possibly lease classification – all of which could affect expenses recognized during the year.
- Related party leases are not appropriately analyzed until year-end, leaving entities surprised when the leases are required to be recognized on the balance sheet.
- After preparing lenders and other users for the impacts of the new standard and possibly renegotiating terms, there are unexpected impacts on debt covenants due to recognizing liabilities for embedded and related party leases. Financial statement users, especially lenders, don’t like surprises.
- You wait until after the end of 2022 to start the transition process. Like those before you, you find that it takes more time and effort than anticipated. As a result, you trigger a covenant violation for failing to timely provide audited financial statements.
Take action now with the new lease standards
There really isn’t any more time to wait. Entities should prepare for transition to ASC 842 now. Ideally, entities will be comfortable with the ASC 842 transition in early 2022 and enable their auditors to perform related audit procedures during interim fieldwork prior to year-end.
Sikich professionals are ready and eager to assist with your implementation efforts. Contact us today to learn more about the new accounting requirements and resources we have to help with adoption.