In February 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standard Update (ASU 2016-02, Leases (codified as ASC 842)) to amend the accounting guidance for leases. On Nov. 15, 2019, the FASB announced a delay in the effective date of the ASU for non-public business entities, who are now required to apply ASU 2016-02 for reporting periods beginning after Dec. 15, 2020.
Do you have a lease? If so, it is important to be aware of the new Lease Accounting Standards for Government Contractors. Lease accounting standards are changing and government contractors need to know how this will affect them.
Lease accounting impacts government contractors and the new rules require them to recognize assets and liabilities related to most leases greater than 12 months, on their balance sheets. Contractors need to be aware of this as it could have a significant impact on their financial statements and how they do business.
Both a right-of-use (ROU) asset and a lease liability must be recognized at lease commencement:
- A ROU asset is one that represents the lessee’s right to use the underlying asset over the term of the lease.
- The lease liability is the amount a lessee owes to the lessor for the use of the underlying asset over the term of the lease.
This change will likely have a significant impact on government contractors, as many currently do not account for operating leases on their balance sheets. In order to comply with these new standards, there could be a negative impact on both their liquidity and capital, with respect to financial ratios. Government contractors with significant lease obligations must record the full value of the lease liability each accounting period.
According to ASU 2016-02, leases recorded on the balance sheet will be classified as financing or operating leases, affecting their income statement presentation. Each year, interest expense and depreciation will be recorded for financing lease arrangements, whereas operating lease assets and liabilities will be amortized and accreted to present value on the income statement.
Impact on Federal Acquisition Regulations
The new lease guidance is not expected to have an impact on the Federal Acquisition Regulations. As a result, government contractors should evaluate whether they need to calculate the depreciation expense, interest expense, and lease expense that will be recognized each reporting period under ASU 2016-02 since the classification of leases as financing or operating would influence the presentation of lease expense on the income statement.
Once Lease Accounting Standards are in place, government contractors will need to restate their financials and make adjustments to account for leases they have not previously accounted for. This may impact liquidity and capital which could negatively affect government contractors’ operations or credit ratings if it is done incorrectly.
The new rules included in ASU 2016-02 are expected to have an impact on government contractors as they require additional disclosures about leasing activities that could result in significant changes to their financial statements and operations. Contractors should consult with their accountants to ensure they are taking all the necessary steps to comply with the new lease accounting standards and minimize any impact on their business.
The effective date of ASU 2016-02 is December 15, 2020 for nonpublic entities so now is the time for contractors to take action to prepare themselves.
The sooner you understand how this will affect your company, the easier it will be to make any necessary adjustments. For more information on Lease Accounting for Government Contractors, contact Neena Shukla, Partner and Leader of the firm’s Government Contracting Team, today.