What You Need to Know about ASC 842
Leasing is something common for companies to acquire assets like office space, vehicles, machinery, and other equipment. Accounting treatment of it is generally a source of complexity and inconsistency. Which makes it difficult for stakeholders to compare financial statements that rent assets. The Financial Accounting Standards Board (FASB) addressed this issue and introduced new accounting measures. ASC 842, changed the way how firms must account for rentals.
To understand, read this resource guide and get a comprehensive overview of the same. And, answer your query, about what you need to know to ensure compliance. Even, this article will give you a brief review of key requirements, their impacts, and the challenges faced by corporations, initially, to prepare for and implement new challenges.
Understanding the Basics
Well! ASC 842 is a newly implemented modular by the Financial Accounting Standards Board (FASB). This is done to replace those old and unreliable accounting measures. The new norm is way more different from the previous one. As it is designed to improve the transparency and compatibility of financial statements for organizations who has rental assets.
With this, the demand to record lease liabilities and right-of-use for it that lasts for more than 12 months is reduced. But, except for those who fit perfectly with the definition of a short-term charter. Lessees must recognize rental assets and liabilities on their balance sheets, which can have significant implications for financial ratios and compliance with debt covenants.
Under FASB’s standard, these are classified as finance or operating lettings. Finance leaseholds are similar to capital ones and have been accounted for rental liabilities and right-of-use assets. Whereas, operating rental agreements result in a charter liability on the balance sheet only.
For a more detailed overview, businesses can refer to the ASC 842 resource provided by EZLease. These resources include accounting examples, webinars, a handbook, and a rental accounting software solution. Additionally, it offers detailed information on the norm itself, including the key changes that were introduced, the new classification criteria for it, and the disclosure requirements for both lessees and lessors.
Key Adjustments Under ASC 842
The FASB criterion introduces several key changes that corporations need to be aware of. The most significant and crucial change is to recognize these assets and liabilities on the balance sheet with terms longer than 12 months. However, this can be impactful on the company’s financial statements. It may require changes to debt covenants and other agreements.
The next important amendment is the classification of it as finance and operating leaseholds. This is typically based on the transfer of control of the service provider to the service seeker. In case, the service seeker has the authority to direct the use of assets and proceed to acquire economic benefits from it, then it will be classified as a finance one. And, if not, it will be categorized as the operating one.
It, even, welcomed new disclosure requirements for both service providers and service seekers. But, the service seeker must disclose a few of the significant judgments. Those judgments are made while applying the standard and the amounts identified in financial statements. On the other hand, the service providers must disclose the nature of their opposite party, significant provisions, and as well as the amount identified in the financial statements.
Implementation of ASC 842
The implementation of this measure seems easy, but it can be a complex process. So, businesses should make a mindset accordingly and prepare to ensure compliance with new standards at their earliest convenience. The foremost step is to determine them and figure out if they are perfect to meet the definition.
There is a lot to think about while considering implementing this criterion. Another factor to be noted by companies is lease terms. These terms are the period of time in which the contracted leasehold is in place. Those terms are inclusive of both the original non-cancelable period and any optional extension or termination periods. The calculations for these should be grounded on the present worth of its payments. Thus, this can be complicated and might demand the assistance of accountants or one who knows how to work with numbers.
Challenges in Implementing ASC 842
Companies may face several challenges while implementing. Primarily, it can be difficult to identify all lettings and assess if they meet the new standard’s definition. This process can be complex, especially for a service seeker with multiple components or variable payments. Another challenge is computing its liability and the right-of-use asset, which involves evaluating the present value of payments and considering factors like incentives, initial direct costs, and the discount rate.
Implementing this may also necessitate changes to accounting systems, processes, and controls to ensure adherence to the new norm. Institutions may need to upgrade their management systems, train employees on the new guidelines, and create new policies and procedures to guarantee ongoing compliance.
The Benefits of ASC 842
Increased Transparency and Comparability of Financial Statements
Recognition of assets and liabilities on the balance sheet provides stakeholders with a clearer understanding of a company’s leasing activities and financial position.
Consistent and Accurate Financial Reporting
This standard mandates businesses to use a single approach to accounting, eliminating the variability that can arise under the previous norms, where rental agreements were classified as operating or capital leases based on different criteria.
This idea also provides clearer guidance on how to account for certain elements, such as options to extend or terminate, which can lead to more accurate financial reporting.
Improved Lease Portfolio Management
Companies can enhance portfolio management by gaining a comprehensive and precise understanding of their leasing operations. Using this insight can uncover potential cost-saving tactics and lead to improved terms. As an outcome, businesses are shifted to make more informed decisions in the near future.
Do you want to know what’s more? So, this sort of standard expected businesses to discord more additional information about their leasing activities. This can be helpful for investors and other stakeholders while evaluating lease-related risks and opportunities.
FASB’s standard provides clear guidelines on how rentals should be accounted for and disclosed, helping firms comply with regulations. Moreover, the new FASB’s norms mandate that companies maintain comprehensive records of their agreements, which can aid in audits and fulfilling regulatory obligations.
To sum up, ASC 842 is the most important, required, and significant change for accounting in this niche. It requires businesses to recognize it on their balance sheets as right-of-use assets and liabilities.
The relief granted by FASB permits firms to choose between the types of discount rate methodology by asset class. It serves increased transparency in financial reporting. Meantime, it delivers an accurate picture of an institution’s financial health. Later, players are supposed to reassess their contracts and update accounting systems and processes. And, are expected to disclose detailed information on the same in their financial statements.
While the implementation of ASC 842 may present challenges for businesses, early preparation and planning can help mitigate these challenges and ensure a smooth transition to the new standard. As such, it’s essential for companies to stay informed about it and seek the guidance of accounting professionals to navigate this complex standard successfully.