Lease Accounting: Considerations for Construction Companies
You’ve been hearing about the new lease accounting standard for quite a while now – and for calendar year-end contractors, it’s about to show the full measure of its impact. The standard, ASC 842, went into effect on January 1, 2022, which will require an entry to move all operating and finance leases to the balance sheet in the form of right-of-use assets and lease liabilities.
A huge percentage of companies that have adopted the standard proactively have found identifying the total number of leases to be immensely challenging – and 76% also say adopting the new standard was at least as or even more complex than revenue recognition.
While assessing your leases in place and determining what their right-of-use assets and lease liabilities are, here are some additional items to consider when compiling your lease population:
1. There could be embedded leases in your contracts you’re not considering.
These embedded leases could include:
- Subcontractor agreements
- Service contracts
- Supply arrangements
If there’s an identified asset being used as part of the contract, and you have the right to control the use of the asset, there may be an embedded lease in that contract that needs to be recorded as a right-to-use asset and liability on the balance sheet. Some items that could be deemed to be leases include parking spaces, cranes and scaffolding, railcars, and storage units.
2. Be sure to understand anything that could increase the period of the lease or measurement of the asset:
- Options to extend the lease by you must be included if you are reasonably certain to exercise.
- Options to extend the lease that’s controlled by the lessor must be included.
- If an option to buy the asset is reasonably certain to be exercised, this needs to be included in the right-of-use asset and lease liability measurement.
If there is a mutual termination option where either party may terminate (or elect to renew) the lease, at the point where those options are available there may not be an enforceable lease and therefore no lease liability or right of use asset is recognized.
3. Remember the types of leases that are outside the scope of ASC 842:
- Leases of intangible assets
- Leases of biological assets (including timber)
- Leases of inventory
- Leases of assets under construction
You may elect to not recognize short-term leases (those with a lease term of 12 months or less) on the balance sheet, however, the amount of expense is still disclosed.
If a policy is put into place to set a lease capitalization threshold similar to property plant and equipment, it needs to be assessed whether that policy will result in a material understatement of the lease liability and right of use asset, as that could lead to adjustments and findings during annual financial statement audits and reviews.
Additional Resources for Contractors
Our resource library contains blogs, videos, and on-demand events to help you navigate the complexities of running a construction business. Be sure to check out our blog, and subscribe to our ask the expert video series to stay appraised of all the changes to lease accounting and more.
If you have any questions, or just want to talk through a business issue, please contact us as you go through this implementation for the 2022 audit, review, and compilation season. We’re here to help.