3 Things Manufacturers Need to Know About Their Accounting for Leases

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CBIZ Manufacturing
& Distribution
2022may very well be the year of balance
for manufacturers, and for private
manufacturers, balance sheets.
As the industry continues to address ramifications from
pandemic-related supply chain disruptions, inflation
concerns, and other market factors, another development
has arrived with a balance sheet impact: changes to lease
accounting guidance. The Financial Accounting Standards
Board (FASB)’s updates to lease accounting will require
companies that lease assets – such as heavy machinery
and equipment, to record all long-term leases on their
balance sheets starting in 2022 for calendar year-end
private manufacturers.
3ThingsManufacturersNeedtoKnow
AboutTheirAccountingforLeases
Below are the core provisions manufacturers should know
about with the lease accounting changes and how the
standard could potentially affect your financial statements.
What is ASC 842?
The FASB introduced ASC Topic 842, Leases, to increase
transparency into the lease accounting for public and
private organizations. The new lease guidance went
into effect in late 2018 for public companies and, after
several extensions, finally went into effect for most private
companies for fiscal years beginning after Dec. 15, 2021.
The new ASC 842 lease accounting standard requires
organizations to record all leases on their balance sheets
except for those meeting the short-term lease criteria. The
goal of the change is to provide a more accurate picture
of an organization’s financial health and offer a better
understanding of its financial commitments.

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The changes affect everything from financial statements
to the lease cataloging process.
How will ASC 842 Affect Manufacturing?
ASC 842 contains guidance for companies that manage
leases (lessors) and companies that lease assets
(lessees). Manufacturers are most likely to find that the
lessee accounting guidance is the most applicable to the
leases that they use in operations.
The lessee accounting guidance classifies a lease as
either a finance lease or operating lease. Finance leases
and operating leases have slightly different financial
reporting requirements for both income statements
and balance sheets. Changes brought about by the new
standard may mean that manufacturers with operating
leases are having to record lease assets and liabilities for
the first time on their balance sheets, which could affect
lending arrangements and other scenarios that rely on
balance sheets as inputs.
Cataloging all of the leases that your organization has
and their corresponding lease type will be an essential
part of your ASC 842 adoption efforts. Each lease may
have both lease and nonlease components that will have
to be separated for financial reporting purposes.
To record the lease assets and liabilities on your balance
sheet, you will need to record the present value of future
lease payments, which may be easier said than done.
The accounting guidance requires that lessees use the
rate implicit in the lease, if readily available, to determine
the present value. It is expected that the implicit rate
will not be known by many lessees; however, scenarios
exist where the rate is known by the organization making
its use a requirement. The alternative is to determine
the appropriate incremental borrowing rate — the rate
the lessee would pay to borrow on a collateralized basis
of a similar term in a similar economic environment —
adjusted for the length of the lease and the country or
region of operation. Private lessees can also elect a risk-
free discount rate accounting alternative for all or a select
class of underlying assets.
Lease modifications and renewals will also be important
to monitor with the new standard.
Leasing ‘Oddities’ in the Manufacturing Sector
Certain types of leases may be harder to transition to ASC
842. One “oddity” that affects the manufacturing sector
are build-to-spec or build-to-suit arrangements.
In a typical build-to-spec or build-to-suit arrangement, a
real property developer builds out real property according
to a tenant’s specifications. Manufacturers may find they
have build-to-spec or build-to-suit arrangements with
their manufacturing plants or even, potentially, with their
specialized equipment resulting in the manufacturer
being, for accounting purposes, the owner of the asset
during the construction period.
ASC Topic 842 makes significant changes to the build-
to-suit rules. A lessee will now recognize the entire
project on its balance sheet during the construction of
the equipment or plant only if the lessee “controls” the
asset during construction. After the equipment or plant
has been completed, the arrangement is evaluated
under the sale and leaseback guidance. If the lessee
manufacturer does not “control” the space or asset
during its construction, any amounts paid by the lessee
manufacturer during construction will be treated as
prepaid lease payments.
Another leasing “oddity” affecting manufacturers are
embedded leases. Manufacturers should pay attention
to their transportation and logistics arrangements
including freight management services, and warehouse
space, as these are often ripe for embedded leases.
Your organization’s information technology may also
have embedded leases related to its servers, data center
spaces, modems, routers, and network equipment.
For More Information
The new lease accounting standard brought about
significant changes for private companies and the
manufacturing industry. Adoption challenges can be
overcome with careful planning and execution, but it will
be necessary for manufacturers to learn all they can
about ASC 842 and how it will affect their business to
make the necessary changes.
For assistance with the lease accounting adoption, please
contact a member of our complex accounting team.
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