Leasing is a common practice for small businesses to acquire equipment, vehicles, and office space. The importance of lease accounting cannot be overstated, as it can significantly impact a company’s financial statements and key performance indicators. However, the lease accounting standard introduced by the Financial Accounting Standards Board (FASB) in 2019 has made lease accounting more complex and challenging. According to a survey by the International Accounting Standards Board, about 85% of leases were not recorded on a company’s balance sheet before the new standard.
ASC 842 requires companies to recognize and report leases as assets and liabilities on their balance sheets. This change was made to provide more transparency and accuracy in financial reporting, as leases are a significant source of off-balance sheet financing. The new standard applies to all leases with a term of more than 12 months, including operating leases, which were previously not required to be recognized on the balance sheet.
This article will discuss some practical tips for small businesses to navigate lease accounting effectively.
Use Lease Accounting Software
Lease accounting can be a complex and time-consuming process for small businesses, especially when they have multiple leases to manage. That’s why using lease accounting software can be a helpful tip for small businesses to simplify the process. Lease accounting software can help small businesses accurately track and manage their lease agreements. The software can also generate accurate reports and analytics to provide valuable insights into lease-related expenses, enabling businesses to make more informed decisions about their leases.
Small businesses that lease assets for their operations must comply with ASC 842, which mandates stricter reporting standards for lease transactions. Failure to comply with the new lease accounting standards can result in misstated financial statements, potential legal and financial consequences, and damage to a company’s reputation.
Keep Detailed Records
Keeping detailed records is an important aspect of lease accounting for small businesses. Lease accounting requires businesses to maintain comprehensive records of all lease agreements and related financial transactions, including lease payments, incentives, and leasehold improvements. Before recording details, it is also essential to identify all your leases, which means gathering information about all agreements to rent assets or equipment, including office space, vehicles, machinery, and other tangible or intangible assets.
Keeping detailed records can also provide businesses with valuable information about their leases, such as the status of each lease, lease-related expenses, and the key terms and conditions. It is also essential to keep track of any changes or modifications to the lease agreement, such as lease renewals, lease extensions, or rent adjustments. Additionally, detailed records can provide auditors and regulatory agencies with the necessary information to verify the accuracy and completeness of a business’s financial statements.
Understand Lease Classification
Another important lease accounting tip for small businesses is to understand lease classification. Leases can be classified as operating or finance leases. This classification has important implications for financial reporting and tax purposes. Operating leases are typically shorter-term leases with lower lease payments. In contrast, finance leases generally are longer-term, with higher lease payments and a transfer of ownership at the end of the lease term.
Understanding the classification of each lease is essential for determining how to account for lease payments, asset and liability recognition, and the calculation of lease expenses. By accurately classifying leases, small businesses can ensure they are according to accounting standards and can make informed decisions about leasing arrangements that align with their financial goals and objectives.
Review Lease Terms Carefully
As a small business owner, reviewing lease terms carefully to avoid surprises or unexpected expenses is crucial. Lease accounting standards require businesses to recognize leased assets and liabilities on their balance sheets, so it’s essential to understand the terms and conditions of any leases you enter into. It includes paying attention to lease length, renewal options, rent increases, maintenance responsibilities, and early termination fees. By thoroughly reviewing lease terms, you can make informed decisions about leasing arrangements and ensure that your business accurately accounts for its lease obligations.
Businesses should also regularly review and analyze their lease agreements to identify opportunities for cost savings and other improvements. For example, it may be possible to negotiate lower rent or lease payments, revise lease terms to better align with business needs, or identify clauses that could be potentially harmful.
Use Appropriate Discount Rates
Businesses should use appropriate discount rates when calculating the present value of lease payments. Discount rates represent the time value of money and reflect the risk associated with the lease agreement. Using an incorrect discount rate can result in significant errors in the lease liability calculation. It can affect the accuracy of the financial statements.
Small businesses should ensure that the discount rate used is appropriate for the lease agreement’s term and reflects the risks involved, such as the lessee’s credit risk, the lease term, and the underlying asset’s residual value. Small businesses need to stay up to date on the latest accounting guidelines to ensure they are using the correct discount rates and accurately accounting for their lease agreements.
Seeking expert advice can help you select an appropriate discount rate and navigate other aspects of lease accounting. It can help ensure that financial statements are accurate and comply with accounting rules, ultimately providing a clear picture of the company’s financial health.
Conclusion
Small businesses should implement best practices in lease accounting to ensure accurate financial reporting and compliance with accounting standards. Key tips include classifying leases appropriately, keeping detailed records of lease transactions, and using lease accounting software to automate the process, reduce the risk of errors, and improve financial transparency. Small businesses can make better-informed decisions about their financial strategies and overall business operations by maintaining accurate lease accounting records. They should also regularly review their lease agreements to ensure they get the best value for their leasing arrangements. Ultimately, the benefits of effective lease accounting practices can lead to greater business success and long-term sustainability.
