The new lease standard requires you to account for leases differently on your financial statements, which of course includes your general ledger. Learn what’s new in this blog, including a few intricacies and potential surprises to watch out for as you implement the standard.
There are two main changes here. The first is an easy one, just a simple name change: capital leases will now be called finance leases. Otherwise, the accounting for these leases will remain the same. You’re still recording the asset, liability, interest, and amortization.
The other change here relates to the main difference in the new lease standard, which is that we must now record operating leases on the balance sheet. It’s important to note that finance leases (formerly capital leases) need to remain separate on the books from operating leases. We’ll discuss operating leases in more depth in the next section.
The addition of operating leases to the balance sheet is the crux of the new lease standard. Before, you only included items like prepaid or deferred rent on the balance sheet, while the operating lease expense predominantly only hit the income statement.
To record an operating lease on the balance sheet, you need to add the right-of-use (ROU) asset and lease liability. See guidance on exactly how to do this in this guide about initial journal entries and this side-by-side example.
Here are some important notes to keep in mind as you transition to the new standard:
- For leases, there is no concept of a short-term asset, so you won’t break out short- and long-term assets (but you will break them out for the liabilities).
- You will not have interest and amortization expenses for the operating leases (like you do for finance leases). The lease expense you booked under ASC 840 will be the exact same that you recognize under 842.
- There is no concept of deferred or prepaid rent for operating leases; instead, you recognize the straight-line lease expense. The difference between cash and that straight-line expense will flow through the ROU asset.
- That brings us to this significant point to keep in mind: in almost every case, equity is not affected when writing initial journal entries under the new standard. This point is important to be cognizant of because we are so used to balancing accounts through equity. Instead, under the new lease standard, differences flow through the ROU asset.
Sometimes it’s easiest to see these types of changes visually. If that’s the case for you, check out our side-by-side examples of balance sheets and income statements before and after the new standard.