If you own, operate or advise a privately owned company that leases equipment such as copiers, computers, factory machinery, vehicles, etc., the not-so-fun time is about to begin. The twice delayed start of the new accounting standards for leased assets – officially ASC 842 – is required to kick in on January 1, 2022, just 6 months away. Public companies have been dealing with this new standard since 2019, and now it’s your turn. So I decided to write a few posts over the next couple months about equipment leasing under the new reporting rules, to help get you started. Most of this material is taken from my online course on lease accounting, available at www.illumeo.com.
First, as a privately owned or family owned company, why do you even care about new accounting rules that are more challenging than the old rules? Well, if your financial reports are only for the management team and the owners, maybe you don’t. But if you have any reason to get your books audited by a CPA firm, e.g. for a bank loan or exit planning, your books will be required to be in accordance with GAAP – Generally Accepted Accounting Principles – and lease accounting under the new rules is an essential part of that. Of course, if that’s not your company, feel free to stop reading.
Wrinkle #1: The new rules apply to all future asset leases, but they also apply to assets already in use in your business. Those previously leased assets will probably have to be restated as if the rules had been in place when they were first acquired. That retroactive arithmetic will likely keep someone busy for quite a few hours recalculating the historical cost pattern under ASC 842.
Wrinkle #2: When you acquire equipment under an operating lease – where your intention is to use the asset for a period of time and then return it – you have typically just paid the monthly rental, expensed it, and nothing ever appeared on your balance sheet. Not anymore. Now those assets, if leased under a term longer than 12 months, must be capitalized on the books. So long-term rentals of equipment are gone.
Wrinkle #3: Do you record that asset at the sum of your committed lease payments? Nope. How about the sum of your lease payments less some imputed interest charge? Nope. The asset gets booked at the present value of all those lease payments, plus any initial direct costs, prepaid rent, and any guaranteed residual value payments. And that amount is then amortized on a straight line over the lease term. The liability gets similarly amortized, after recognizing the interest component at an appropriate rate.
So why did this happen anyway? Simply, because the world outside your company wants to compare your cost of doing business with comparable companies that buy their assets instead of leasing them. That comparison is distorted when assets are reported differently on balance sheets and income statements.
Stay tuned for more.
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