Understanding ASC 842

Lease accounting standards like ASC 842 might not be on your immediate radar as a restaurant, retail or any other franchise owner. However, understanding the impact of this lease accounting standard, and how lease accounting software can simplify compliance, is crucial. In this blog post, we’ll break down what ASC 842 is, explore its implications for franchise owners, and provide real-world examples to give you a comprehensive understanding.

ASC 842: The Basics

So what is ASC 842? ASC 842 lease accounting standard that mandates companies to recognize lease assets and liabilities on their balance sheets, enhancing transparency in financial reporting. ASC stands for Accounting Standards Codification and it has changed the game for businesses. This updated lease accounting standard issued by the Financial Accounting Standards Board (FASB), represents a significant shift in how companies report their leased assets and replaces the previous off-balance-sheet accounting approach for operating leases that was stipulated under the former US GAAP lease standard, ASC 840.

Lease Amortization Schedule: Bringing Leases to Life

One crucial aspect of this standard is the amortization schedule, which outlines how deferred rent and other lease-related costs are allocated over the lease term. For franchise owners, this means understanding how lease payments affect your financial statements over time.

Let’s dive into an example:

Imagine you’ve signed a lease for a new location with an annual payment of $200,000 over a five-year term. Using this lease accounting standard, you’d create an amortization schedule that allocates the annual cost across the five years. This could look something like this:

- Year 1: $200,000

- Year 2: $200,000

- Year 3: $200,000

- Year 4: $200,000

- Year 5: $200,000

Journal Entries: Documenting the Financial Story

Understanding journal entries is key to complying with ASC 842. Let’s break down a scenario relevant to your retail franchise:

Suppose you’ve just signed a lease for retail space with an annual payment of $30,000.

Your journal entries would look like this:

- Initial Recognition (Day 1):
  - - Debit: Right-of-Use Asset $150,000 (5 years * $30,000)
  - - Credit: Lease Liability $150,000

- Annual Lease Payment:
  - - Debit: Interest Expense $X (calculated based on the outstanding lease liability and interest rate)
  - - Debit: Lease Liability $30,000 – Interest Expense
  - - Credit: Cash $30,000

Lease Classification Under the New Standard

Understanding Lease Types: Operating vs. Finance

In the world of lease accounting, distinguishing between operating and finance leases is pivotal. Under the current financial framework, a finance lease is akin to ownership, signifying that the leased asset is practically yours. Operating leases, conversely, are more like traditional rental agreements.

For restaurant and retail franchises, this distinction is crucial. It affects how leases appear on financial statements, impacting key metrics used by investors and creditors. The criteria for each lease type under the latest regulations differ from past practices, emphasizing the need for careful evaluation of each lease agreement to ensure accurate classification and reporting.

ASC 842: Lease Accounting Standards in Action

Let’s explore some ASC 842 examples to see how this impacts your restaurant or retail franchise in various scenarios:

- Refreshing Your Space: Imagine you decide to give your restaurant a facelift by leasing new furniture. ASC 842 requires you to recognize both the lease asset and liability on your balance sheet.

- Expanding Your Storefront: If you’re expanding your retail space, ASC 842 ensures that the costs associated with the lease are accurately reflected on your financial statements, influencing your balance sheet.

- Upgrading Kitchen Equipment: Leasing state-of-the-art kitchen equipment? ASC 842 mandates recognizing the asset and liability, providing a comprehensive view of your financial commitments.

Impact on Financial Statements and Ratios

Navigating Balance Sheet and Income Statement Adjustments

The shift in lease accounting practices significantly influences your franchise’s financial statements. This change primarily affects the balance sheet, where lease obligations now appear as liabilities, and corresponding right-of-use assets.

These adjustments can alter crucial financial ratios, such as debt-to-equity and return on assets, impacting how lenders and investors view your financial health. Understanding these implications is key to managing perceptions and maintaining robust financial strategies. It’s not just about compliance; it’s about smart financial storytelling.

How to Gauge if ASC 842 Might Apply to Your Business

This new standard will most likely impact your business or franchise, so let’s break down how it applies specifically to restaurant and retail owners.

1. Lease Agreements: What You Lease Matters

ASC 842 primarily targets lessees, those entering lease agreements to use assets or spaces. For restaurant and retail owners, this includes leases for crucial elements like real estate, equipment, or vehicles, including sales type leases. If you’re leasing any of these, ASC 842 likely applies, influencing how you account for these assets on your balance sheet.

2. Lease Term: The Long and Short of It

ASC 842 is concerned with long-term leases, typically those exceeding 12 months. If your business mainly engages in short-term leases—say, for a pop-up store lasting less than a year—you might catch a break. Short-term leases that you choose not to recognize on the balance sheet could be exempt from ASC 842 reporting.

3. Materiality Thresholds: Size Doesn’t Always Matter

While a materiality threshold exists, don’t be too quick to assume your smaller leases fly under the radar. Even seemingly modest leases may require disclosure in the footnotes of your financial statements. It’s essential to carefully assess the value and impact of each lease.

4. Lessor vs. Lessee: Know Your Role

For those leasing out assets, ASC 842 is less directly applicable. However, if your business primarily acts as a lessee—leasing spaces, equipment, or vehicles—get ready to navigate the accounting changes. Even lessors need to be aware of potential impacts on lessees, shaping how business relationships unfold.

5. Intangible Assets: Beyond the Tangible

Leasing isn’t limited to physical spaces and equipment. Intangible assets, such as software licenses, patents, or trademarks, may also fall under ASC 842. Carefully reviewing lease agreements involving intangible assets is essential to ensure compliance.

6. Low-Value Leases: Small but Significant

Good news for businesses with numerous small leases—ASC 842 includes a practical expedient for recognizing low-value leases. If the value of the underlying asset is considered low, you may opt not to recognize it on the balance sheet. This provides relief for those juggling numerous smaller leases.

7. Public vs. Private Companies: Timelines Matter

Effective dates for ASC 842 implementation vary for public and private companies. Public companies likely adopted the standard earlier, while private companies have their own timelines. As a restaurant or retail owner, be aware of your company’s status and the relevant effective dates to stay ahead of the game.

Carefully reviewing lease agreements, considering lease terms, materiality, and the nature of leased assets is essential for restaurant and retail owners. If uncertainty lingers, consulting with an accounting professional can provide clarity and ensure your compliance with ASC 842.

Transitioning to the New Lease Standard

Step-by-Step Guide for Smooth Adoption

Transitioning to the latest lease accounting standard is a multi-step journey. Start by gathering all your lease agreements and extracting key data points. Next, focus on recalculating your lease liabilities and assets in line with the new criteria.

This phase may require retroactive adjustments and a thorough review of your financial history. Tools like Leasecake can simplify this complex process, offering an efficient pathway to reorganize and report your lease data under the new standard. Remember, a smooth transition sets the stage for ongoing compliance.

Consequences of Non-Compliance with ASC 842

Failing to comply with ASC 842 can lead to various consequences for your franchise, including financial reporting inaccuracies, potential legal consequences, and challenges with audits.

- Financial Reporting Accuracy: ASC 842 aims to enhance financial reporting accuracy and transparency. Non-compliance may lead to misleading financial statements, impacting how stakeholders and investors perceive your business.

- Audit Concerns: Non-compliance with accounting standards can trigger audit issues, with auditors identifying weaknesses in internal controls. This can diminish confidence in the reliability of your financial statements.

- Legal and Regulatory Risks: Regulatory bodies may impose fines for ASC 842 non-compliance, considering it a violation of financial regulations. Restaurant and retail owners need to be vigilant to avoid legal consequences.

- Investor Trust Erosion: Inaccurate financial reporting can erode investor confidence. Stakeholders, including investors and creditors, rely on accurate financial statements for informed decisions. Non-compliance may result in a lack of trust in your business’s financial disclosures.

- Contractual Breaches: Lease agreements often include covenants tied to financial reporting. Non-compliance with ASC 842 may breach these contracts, leading to penalties outlined in lease agreements for restaurant and retail owners.

- Financing Implications: Lenders and creditors closely scrutinize financial statements. Non-compliance with ASC 842 could impact your ability to secure financing or renegotiate credit agreements, potentially leading to higher borrowing costs.

- Operational Challenges: Non-compliance brings operational challenges. Failing to implement ASC 842 systems and processes can make it difficult for restaurant and retail owners to manage leases, track financial obligations, and make informed strategic decisions.

Employing a robust lease accounting tool, such as Leasecake, can help avoid these consequences and ensure ongoing compliance with ASC 842 standards as well as other lease standards.

Best Practices for Ongoing Compliance

Maintaining Accuracy and Timeliness in Reporting

Consistent compliance with the updated lease standard demands vigilance and strategic processes. Regularly review your lease agreements for any changes that might affect reporting. Stay abreast of any amendments to the standard and adapt your practices accordingly.

Key to this is an educated and well-informed accounting team, supported by robust software tools. These tools not only track lease terms and payments but also provide alerts for critical dates and changes, ensuring that your reporting remains accurate and timely.

Download the Free Guide: Secrets to ASC 842 Compliance

Our team of real estate experts has compiled the steps your team should take to get up to speed with ASC 842.

Mitigating the Risks

To navigate ASC 842 successfully, be proactive. Understand the standard, implement necessary changes, and consider seeking guidance from accounting professionals. Regular training for your finance and accounting team is crucial for ongoing compliance.

Specialized software solutions, such as Leasecake, facilitate seamless navigation of lease accounting 842 standards for restaurant and retail operators.. Our customers love how easy to use it is, and how quickly they can pull reports and integrate their data with other platforms like R365, Quickbooks, and Netsuite.

One of our customers, Jeff Springer, CPA and Accounting Manager at Ruby Slippers Cafe, says, “Leasecake is a dynamic tool that allows us to generate rent schedules for any location in
minutes. It’s helped us have more financial clarity as we’ve built new locations.” Read more in the Ruby Slippers case study.

Leveraging Technology for Lease Accounting

In today’s digital-first business environment, leveraging technology for lease accounting is not just a convenience; it’s a necessity. Advanced software solutions, like Leasecake, automate the tedious aspects of lease accounting, from calculations to compliance checks.

These tools go beyond mere automation; they offer analytics and insights, helping you make informed decisions about your lease portfolio. They turn data into actionable intelligence, ensuring that your lease accounting is not only compliant but also contributes to your broader business strategy.

In Conclusion

While navigating these lease accounting changes might seem daunting, comprehending their implications is key for restaurant and retail franchise owners. By grasping the amortization schedule, journal entries, and real-world examples tailored to your industry, you not only comply with the new lease accounting standard but also gain a more accurate financial representation of your franchise. Stay informed, stay compliant, and navigate the lease accounting landscape with confidence.

If you’d like to learn more about Leasecake’s lease accounting software, schedule a demo today!

Taj Adhav

Taj Adhav is the Founder of Leasecake, an award-winning real estate management platform. With experience in accounting, Disney Imagineering, and tech, Taj simplifies location management for multi-unit operators in the retail and restaurant industries.

Understanding ASC 842 for Lease Accounting