Common Lease Accounting Pitfalls to Be on the Lookout For
Before financial institutions were focused on the current expected credit losses (CECL) for calculating the allowance for loan losses, updated lease accounting rules were adopted in 2022. Issued by the Financial Accounting Standards Board (FASB) in 2019, ASC 842 involved a significant shift in reporting lease obligations on financial statements. These updates included:
- Establishing a right-of-use asset and lease liability on the balance sheet for operating leases measured using the present value of the future lease payments.
- Future lease payments now include noncancelable periods in the lease, plus options that are reasonably certain to be exercised (greater than probable based on contract, asset, market and entity-based factors).
- The discount rate used to calculate the present value of the future lease payments is now the implicit rate in the lease (when readily determinable), or the incremental borrowing rate (when not readily determinable) on the lease commencement date.
As financial institutions continue to perform ongoing analysis and calculations, Doeren Mayhew has outlined below common lease accounting pitfalls to be on the lookout for before your next financial statement audit.
Future Lease Payments
- Optional periods missing that are reasonably certain to be exercised.
- Including optional periods that were not reasonably certain to be exercised.
- Not including lease payments for retail, new premises and other small spaces included in the lease agreement.
- Not considering annual payment increases (3% increases per year).
- Including space rented out to others (rental income) to reduce future lease payments.
- Leveraging the same discount rate for all leases instead of considering the incremental borrowing rate for a loan term similar to the lease term, such as using the five-year rate for a five-year lease.
- Using the discount rate on the lease commencement date that commenced prior to the date of adopting the standard.
- Updating the discount rates monthly or annually to the current rates.
- Using 0% as the discount rate.
Other Key Items
- Misclassifying the right-of-use asset or lease liability on the balance sheet.
- Mislabeling the right-of-use asset or lease liability general ledger account description.
- Not creating a lease policy to include elections of practical expedients and accounting policy elections.
How to Avoid Pitfalls
Staying proactive is key to helping avoid issues that can arise from your next financial statement audit or regulatory exam. Your institution may want to consider partnering with a qualified third party to have a lease accounting review, or any new accounting standard review, performed to stay ahead of any changes and help ease your financial statement preparation. Contact Doeren Mayhew’s Financial Institutions Group today to learn more about how we can help.By Alexander Brennan, CPA – Senior Audit Associate