The new lease standard has revolutionized the way we report operating leases. By definition under the new lease standard, an operating lease is “an agreement that has an identified asset and a right to control the identified asset over a period of time, where the agreement does not otherwise meet the finance lease criteria.” We are used to accounting for these leases solely on the income statement, but the new lease standards will require that operating leases now recognize a right-of-use asset on the balance sheet, along with a lease liability. As we have discussed before, this will cause issues with debt covenant compliance.
Operating lease liability.
An operating lease liability is the sum of remaining minimum rental payments under the operating lease, discounted by an applicable interest rate. Operating lease liabilities will be broken out between their current and non-current components. Operating lease liabilities must be reported separately from other liabilities on the balance sheet (including being separate from finance lease liabilities).
Operating lease right-of-use asset.
An operating lease right-of-use asset is reported separately from other assets on the balance sheet (including being separated from finance lease right-of-use assets) and will be classified as non-current. Right-of-use assets are recognized at inception as the value of the related lease liability, less any previously recorded deferred rent liability that may have been reported per legacy GAAP.
Income statement expense recognition.
Under new GAAP, operating leases will continue to recognize a single lease cost, so that the cost of the lease is allocated over the lease term generally on a straight-line basis. Therefore, there is no impact on net income or retained earnings expected from the adoption of the new lease standard.
The new lease standard is effective for private companies for annual reporting periods beginning after December 15, 2020 (2021 calendar year).
Please contact a member of your Corrigan Krause advisor team, or email info@corrigankrause.com for further discussion.