For private companies and nonprofits, ASU 2016-02, Leases (ASC 842), is now effective for fiscal years beginning after December 15, 2021. Many companies and organizations may have waited to adopt these changes and may continue to hold off until their annual financial statements are due — but with Dec. 2022 around the corner, there is little time left to postpone. If it has not been considered already, the time is now.
THE BASICS OF ASC 842
It is hard to believe it has already been two years since GHJ published its succinct ASC 842 guide. Whether a person is learning about ASC 842 for the first time or in need of a refresher, the guide is a great introduction for lessees and makes the path to implementation clearer and less daunting.
Further, GHJ has a library of resources and a team of experts that can assist with the full-scope implementation of ASC 842, which includes the calculation of right-of-use assets(s), lease liabilities, journal entries and financial statement disclosures — all in accordance with generally accepted accounting principles (GAAP) in the United States, of course.
THE EFFECT OF ASC 842
Any company with loans, credit facilities or factoring arrangements that require compliance with certain financial covenants is likely to be impacted by ASC 842. Let this blog serve as a kind reminder to discuss with your bank the implications of ASC 842 on your financial metrics.
To put it succinctly, after ASC 842 implementation, a significant right-of-use asset and lease liability may be recognized on the balance sheet. This could impact key financial ratios and covenants typically applied by banks, such as debt-to-equity, other leverage ratios, tangible net worth, fixed charge ratios, etc. EBITDA (earnings before interest, taxes, depreciation and amortization) will not be impacted in the case of operating leases. However, if a lease previously qualified for operating lease accounting under legacy GAAP but now qualifies for finance lease accounting under ASC 842, EBIDTA will be favorably impacted.
ASC 842 could also cause a company to breach its financial covenants. GHJ strongly recommends that companies discuss the impact with their bank and negotiate covenant calculations to be adjusted to offset any unfavorable impacts of ASC 842.
For any assistance in implementing ASC 842 or in understanding its impact on specific key performance indicators (KPIs), GHJ’s Audit and Assurance Team is here to help businesses navigate.