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Private Companies: Are You Ready to Report Leases on Your Balance Sheet?

September 30, 2021

Your company may have to update its tracking of leases to comply with enhanced disclosure requirements. Here’s what you should know.

New lease accounting rules were approved in 2015. The updated guidance represents a major change to how leases have been reported on financial statements under U.S. Generally Accepted Accounting Principles (GAAP). In addition to bringing all long-term lease obligations onto the balance sheet, your company may have to update its tracking of leases to comply with the enhanced disclosure requirements.

Businesses have been given several years to prepare their accounting practices and systems for these changes. The updated lease guidance went into effect in 2019 for calendar-year public entities. Many companies that implemented the changes quickly discovered that compliance required more time and effort than they originally anticipated.

Now, after being postponed twice, the updated lease guidance goes live for private entities for annual reporting periods beginning after December 15, 2021, and for interim periods within fiscal years beginning after December 15, 2022. But a last-minute amendment will help ease the transition. Here’s the latest.

Two Delays

After hearing concerns from private companies about the scope and complexity of the lease guidance, in 2019, the Financial Accounting Standards Board (FASB) deferred the effective date with Accounting Standards Update (ASU) No. 2016-02, Leases, to 2021 for private entities.

When the COVID-19 pandemic hit in 2020, the FASB decided to extend the effective date of the updated leases standard for private entities by another year. Many businesses welcomed the temporary reprieve while they dealt with unprecedented disruptions to their operations during the pandemic.

A FASB meeting on September 22, 2021, revealed that some private companies still aren’t ready to implement the changes. In fact, one agenda request the FASB is currently fielding asks for an additional two-year deferral for private entities. No delay has been formally proposed yet. Unless the FASB obliges at the last minute, private companies will need to on-board the changes for the 2022 fiscal year.

Simplified Alternative for Private Companies

But there’s some good news for private companies that are struggling to implement the updated guidance on leases: The FASB recently approved a narrow-scope amendment that will allow private company lessees to use a risk-free rate (such as the Treasury bill rate approximating the lease term) as the discount rate to estimate the present value of payments for all leases.

Under the amendment, private companies can elect to use the risk-free rate, as opposed to an incremental borrowing rate, at an underlying asset class level rather than for the entire portfolio of leases. The discount rate directly affects lease classification (operating or financing) and the measurement of a lease liability and corresponding right-of-use asset. Using a risk-free rate will be a more flexible, less costly accounting option for many lessees. The only caveat is that risk-free rates are generally lower than the company’s incremental borrowing rate which could result in a higher lease liability.

We Can Help

Don’t wait until year end to adopt the new rules for reporting leases. Contact us to help evaluate which of your contracts must be reported as lease obligations under the updated guidance. We can also explain whether the option to use a risk-free rate makes sense for reporting your company’s leases.

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