What Are the New Lease Accounting Standards?

Lease accounting standards have undergone major changes over the last decade. As a business owner, it’s important to stay up to date to ensure you’re compliant and transparent with your accounting.

Understanding what’s changed—and why—will help you keep your books clean and your business audit-ready.

Curious what it means for your business? Let’s dive in.

Why Did the Lease Accounting Standards Change?

For years, lease accounting had a major blind spot. Under the previous standards, ASC 840 and IAS 17, operating leases like rental agreements were not reflected on companies’ balance sheets, even if they had been paying them for years. This meant that companies could drastically understate their liabilities and financial commitments. 

Some companies knowingly took advantage of this loophole, purposefully manipulating their financial statements to hide the true financial state of their operations and seem more profitable to shareholders.

This lack of transparency raised red flags for investors, lenders, and shareholders who relied on those balance sheets to make high-stakes financial decisions. The new standards were introduced to close that gap, boost accountability, and give a truer picture of a company’s obligations. 

What are the Goals of the Updated Standards?

There were several primary goals when it came to updating the lease accounting standards:

• Improve financial transparency: All assets should be recorded on the balance sheet, including those that are rented or leased.
• Improve comparability: Organizations that purchase their assets should be able to directly compare themselves with organizations that lease their assets.
• Increase accountability: Stakeholders, lenders and business owners should be able to make better-informed decisions with their money.

ASC 842 (U.S. GAAP)

ASC 842 replaced ASC 840 in fiscal years starting after December 15, 2018 for public companies, and December 15, 2021 for private companies and nonprofits. 

This standard requires that assets leased for 12 months or longer must be recorded on a company’s balance sheet. Companies must conduct a lease inventory and review all existing lease contracts. This includes service agreements that contain embedded leases.

ASC 842 maintains ASC 840’s dual lease classification system. Leases are classified as either “finance” or “operating.” 

Under ASC 842, both types of lease now appear on the balance sheet. This streamlines the recording process and closes a loophole where operating leases did not have to be recorded on balance sheets.

ASC 842 also expands disclosure requirements. Companies must disclose information about their lease terms and conditions, discount rates, maturity analysis and more.

IFRS 16 (International Standard)

IFRS 16 replaced IAS 17 beginning January 1, 2019. 

Like ASC 842, this standard requires all companies reporting under International Financial Reporting Standards to record their leases on their balance sheets.

There is one key difference between the two standards: IFRS 16 operates with a single-lessee model, a significant change from IAS 17’s dual model. This means that all leases are treated similarly, reducing the distinction between operating and finance leases.

Right-of-use (ROU) assets and lease liabilities now need to be recognized for each lease agreement, providing consistency across your financial statements and simplifying accounting rules.

Key Changes in Lease Accounting

The new lease standards introduced many small but significant changes, including:

• All leases over 12 months must be reported on the balance sheet. As previously mentioned, requiring all long-term leases to be reported ensures that companies’ obligations are made more transparent. This gives a more accurate picture of a company’s financial health and closes certain loopholes found in previous standards.
• Identification of embedded leases. Embedded leases are a type of contract in which a company is given the right to control an asset for a certain period of time for an agreed-upon payment. New standards better define embedded leases and require them to be recorded.
• New disclosure requirements. Companies are now required to provide more detailed disclosures in their financial statements. Anyone reading a company’s balance sheet should be able to understand its lease agreements and future cash flows.
• Need for updated systems and processes. Companies need to upgrade their systems to ensure that they are properly tracking changes to their leases and payment terms.
• Reassessing existing lease contracts. On top of updating all internal systems, companies should also examine all existing lease contracts to assess whether any modifications are required to stay compliant.

What Businesses Need to Do 

Business owners should always stay up to date with lease accounting standards to ensure that they are completing their accounting correctly.

Recognize ROU Assets and Lease Liabilities 

All your assets need to be accounted for appropriately. Under IFRS 16, ROU assets and lease liabilities now need to be recognized for each lease agreement. Conduct an audit and determine all qualifying leases that need to be taken into account.

Choose a Method for Transition and Adoption 

When new lease standards are implemented, there is naturally a period of time where your company will need to adjust to the change. 

As the transition deadline approaches, you’ll need to choose whether you wish to apply the new standard to all previous periods (full retrospective method) or whether you will apply the new standards only to reporting periods required by the new standards (modified retrospective method).

Update Accounting Policies and Train Staff 

Any staff members who work with company accounts need to be trained to ensure that they understand the details of the new standards. Or, communicate with your outsourced accounting team to ensure that they’re making appropriate changes.

Consider Lease Accounting Software for Compliance 

Lease accounting can be complex, but software can simplify the process. Tools like QuickBooks Online update automatically, helping you stay compliant. Software also helps you automate bookkeeping tasks, track changes and reduce the possibility of manual errors.

Collaborate with Auditors Early 

Don’t wait until the last minute to start working on your accounting. Reach out to auditors or outsource your bookkeeping early on in the accounting process. Financial advisors like our team at Finvisor help you avoid errors and misclassifications, as well as offer best practice suggestions to help your accounting run smoothly well into the future.

Contact us today to get expert support tailored to your business!