Five Challenging Lease Accounting Disclosures Companies May Encounter
With the new lease accounting standard being effective for the 2021 year for calendar year non-public entities, and while many are focused on the accounting adjustments that will be necessary to recognize their operating leases on the balance sheet, a less apparent challenge is looming in the financial statement disclosures that will be necessary. Following are some of the more challenging lease disclosures.
- Variable lease cost. A lease may include both fixed and variable payments. Variable lease payments are those that vary based on changes in factors after lease commencement (i.e., rent is based on a percentage of sales). Only the fixed lease payments are included in the lease liability. Determining variable lease cost will likely require a manual exercise of analyzing payments to the lessor during the reporting period.
- Short-term lease cost. A lessee may elect not to apply the recognition requirements to short-term leases, which are those with a lease term of 12 months or less at the commencement date (i.e., equipment leased for 6 months). Most entities will not track their short-term leases in lease accounting software, so they will need to establish a way to track short-term lease payments for disclosure.
- Significant judgements and assumptions. Determining whether a contract contains a lease may require significant judgement, including whether there is an identified asset, if the entity has the right to substantially all economic benefits, or if the entity has the right to direct the use of the asset. In addition, determining the lease term may require judgement in leases that contain renewal or termination options.
- Transition disclosures. Lessees will provide transition disclosures required by ASC 250, including the nature and reason for the change in accounting principle and the transition method applied. In addition, entities are required to disclose the use of any of the transition practical expedients that are elected. Our experience indicates that most private entities, although not required to, prefer to present comparative statements, and most do not retrospectively apply the standard to the prior year since it is not required. However, when presenting both periods under different standards, each year has differing disclosure requirements which can be extensive and confusing to the users.
- Weighted average discount rates and remaining lease term. A lessee is now required to disclose these items, which can be challenging, especially if lease accounting software is not used. Judgement may be involved in determining discount rates, although non-public entities are permitted to use a risk-free rate.
The extent and level of detail required to meet the disclosure requirements will largely depend on the level of significance of an entity’s leasing activities to its business.
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