Kevin J. Bonnett, CPA
Vice President & Director

Although the implementation of the significant new lease standard, ASC 842, has been completed by all companies, as adoption was required for all companies with fiscal years beginning after December 15, 2021, this standard cannot be forgotten. It must be followed as new lease agreements are signed or existing lease agreements are modified.   

In many ways the ongoing application of this standard is more complex than the initial adoption. The practical expedients available to simplify the initial adoption are no longer applicable to new or modified contracts/agreements, and a change to an existing lease agreement requires significant judgement to evaluate how the change is accounted for.

Practical expedients

For the initial adoption of the leasing standard, FASB provided a package of three practical expedients to simplify implementation for existing agreements. These expedients are no longer allowed for newly signed agreements, which adds complexity to evaluating new contracts and agreements. These three expedients for existing agreements at adoption allowed agreements to be treated the same as the previous standard in the following ways:

• At the time of implementation, existing contracts did not need to be evaluated to determine if they were a lease or if they contained a lease component. For any new contracts signed, a detailed evaluation must be completed to determine if they meet the criteria to be a lease or if there is a lease component within the agreement, which could cause contracts which were not previously viewed as lease agreements to follow the standards of ASC 842. The most common example of a contract containing a lease component relates to third-party data hosting services being provided within a cloud-based software contract. If data is being stored on a designated server, it is possible a portion of this contract will be deemed a lease under the new standard.
• Evaluating the lease classification as operating vs. a finance type lease. Although ASC 842 defines these two types of leases in a similar manner as the old standard there are no longer “bright line” assessments to determine classification, requiring an increased level of judgement to classify new lease agreements.
• Under the new standard fewer costs are eligible to be capitalized as part of the right-of-use asset. In order to be capitalized under ASC 842 costs must be incremental costs that are incurred only if the lease is executed. This change will cause more costs associated with executing a contract/lease agreement, such as attorney review costs, to be expensed instead of capitalized as part of the leased asset.

Lease modifications

A lease modification refers to any change in the scope, terms or conditions of a lease agreement after its commencement date, such as changes in lease payments, lease term or to the specific assets being leased (adding additional assets or removing assets). Under ASC 842, these modifications must be assessed to determine whether they should be accounted for as a new separate lease agreement or as an adjustment to an existing lease contract.

If a lease modification results in a change in the asset being leased, such as adding or removing leased assets, it is accounted for as a separate lease under ASC 842, requiring the lessee to recognize a new right-of-use asset and lease liability based on the modified terms. Lease modifications that do not change the assets being leased, but affect lease payments or lease terms, are generally accounted for as adjustments to existing lease contracts requiring the existing right-of-use asset and lease liability to be adjusted based on the modified terms using the current discount rate.

The way in which new or modified agreements are classified can have a significant impact on the financial position and financial results of a company.

If you have any questions regarding a lease contract you are signing or a modification to an existing lease contract, please contact your G.T. Reilly advisor to discuss the agreements.