Due to the impact of Coronavirus Disease 2019 (COVID-19), the Financial Accounting Standards Board (FASB) has granted a one-year effective date delay for certain companies and nonprofit organizations applying the revenue recognition (ASU 2014-09, Revenue from Contracts with Customers-Topic 606) and leases guidance (ASU 2016-02, Leases-Topic 842).
FASB issued the Accounting Standards Update (ASU) to allow certain organizations who have not yet applied the revenue recognition and leases guidance to delay their implementation by one more year, providing these stakeholders a measure of relief during this unprecedented time.
Specifically, the ASU permits private companies and not-for-profit organizations that have not yet applied the revenue recognition standard to do so for annual reporting periods beginning after December 15, 2019, and interim reporting periods within annual reporting periods beginning after December 15, 2020. Early adoption of the Leases standard continues to be permitted, which means that a nonprofit organization may choose to implement Leases before these deferred effective dates
McConnell & Jones knows that a delay in implementation is be the biggest risk of all! We have included an overview of the update below as well as key steps your organization can do today to keep you ahead of the required implementation timeline.
Overview of the Revenue Recognition and Leases Standard
If your organization has not already started the process of applying revenue recognition and leases standard, then you’ll want to know that most significate difference between is that all leases with terms of over 12 months will now be recorded on the balance sheet.
Under the standard, leases will now be classified as either an operating or financing lease and accounted for as a “right-of-use asset” on the balance sheet. Lessees will also record a lease liability associated with the right-of-use asset at the commencement of the lease, based on the present value of future lease payments discounted using the rate implicit in the lease. The lessee is also allowed to use its incremental borrowing rate if that rate is not provided in the lease agreement. The new standard permits the lessee to exclude the recognition of right-of-use assets and lease liabilities for leases with a term of 12 months or less.
The new standard classifies a lease as a finance lease if any of the following criteria applies, otherwise the lease is classified as operating lease:
- The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
- The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
- The lease term is for the major part of the remaining economic life of the underlying asset. However, if the commencement date of the lease falls at or near the end of the economic life of the underlying asset, this criterion shall not be used for purpose of classifying the lease.
- The present value of the sum of lease payments and any residual value guaranteed by the lessee not already reflected in lease payments equals or exceeds substantially all of the fair value of the underlying asset.
- The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.
Additionally, the lease standard defines a lease as “a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration.” Therefore, companies will need to review all their contracts to determine whether or not they contain a lease and, if so, the company will segregate the lease components from the contract and recognize a right-of-use asset and lease liability.
Steps to Consider If Still Implementing the Standard
Entities will need to implement new, or change existing, business processes and internal controls to ensure compliance with the new guidance. The following considerations should be considered as you begin the transition.
#1 Understand the impact of the standard:
Recognize how the changes will affect not only accounting policies, but also the systems used to manage leases. Consider other ramifications of applying the new lease standard beyond the organization’s financial statements, such as the impact on key financial ratios included in debt covenants or key performance indicators used to manage the company.
#2 Gather information:
Obtain current and in-process lease agreements as well as relevant policies, procedures, data and systems involved.
#3 Evaluate the impact:
Establish a cross-functional team, inclusive of accounting, tax, purchasing, IT, and legal, to evaluate the impact across the entire organization.
#4 Select a transition approach:
Plan for required system enhancements, such as updating financial accounting software and purchasing add-on solutions.
#5 Design a solution:
Develop a project plan and timeline and secure necessary resources to meet the effective date.
#6 Implement and monitor:
Execute the project plan, monitor status, and communicate with relevant stakeholders.
McConnell & Jones works to deliver tailored solutions to efficiently address each of our clients’ needs when transitioning to the new standard. Contact our team today with your questions – we’re ready to help.
Marlon Williams, CPA
Public Assurance Services
Johnson Olatunji, CPA
Senior Assurance Manager
Public Assurance Services