If you have a lease, there’s a good chance you’ve heard of ASC 842. Maybe you’re on our website looking for a way to manage your leases or ensure you comply with the new lease accounting standard.
If that’s the case, then we’re here to give you a high-level understanding of the standard, its business implications, and the steps you can take to facilitate a smooth transition from your previous method of accounting for leases.
ASC 842 is a new FASB lease accounting standard that public companies adopted in 2019. Private companies were to implement ASC 842 after December 15, 2021, for the 2022 fiscal year to comply with Generally Accepted Accounting Principles (GAAP).
In the past, under ASC 840, the previous lease accounting standard, transactions associated with leases flowed through the profit and loss statement and touched the balance sheet through cash or deferred rent. However, under ASC 842, nearly all of your leases of one year or more must be shown on the balance sheet simultaneously as a right-of-use asset and lease liability at the net present value (NPV).
A primary motive behind the roll-out of ASC 842 is financial statement comparability. This new model makes it easier for lenders, investors, and others to compare one company to the next if the balance sheet reflects all liabilities.
While initially, this new standard may not seem like a significant change, Jonathan Martin of Horne said otherwise during a webinar hosted by Leasecake CEO Taj Adhav. “This is probably the most impactful, most far-reaching standard in the past two decades if you think about how leases were accounted for,” Martin said. “There’s over $3 trillion of unrecorded impacts to financials that are missing from financial statements, so it is significant.”
Where previously, leases only affected a couple of balance sheet accounts, now there will likely be six or seven accounts on your balance sheet that need to be updated quarterly, if not monthly.
“The fact that this is the biggest change in accounting standards in over 20 years is a big deal,” Martin said. “It’s not very often that you can say that unless you’re talking about income taxes. But when it comes to compliance like this for private sector companies, it’s so important”.
As ASC 842 is still in the implementation process, it is vital to have your ducks in a row to ensure a smooth transition. There are various items to consider, such as organizing lease documents, retaining complete rent schedules, determining interest rates for NPV calculations, and maintaining lease abstracts.
“Many large publicly held companies are going through a complete reassessment of their lease rent schedules because they weren’t correctly abstracted,” Adhav said. “So the accuracy of your financial status depends very much on the accuracy of those rent schedules.”
ASC 842 considerably affects business decisions. For example, your accounting department will need to spend more time on the monthly closing process as accounting for ASC 842 is more time-consuming than accounting for ASC 840. These tasks may result in budgeting, staffing, or procedural changes.
Perhaps you track lease details using a spreadsheet. Unfortunately, this method won’t work well under the new standard, especially with multiple leases. It’s too difficult to remain in command of the volume of data and not lose track of details.
Additionally, ASC 842 will affect business decisions regarding liabilities. On the balance sheet, liabilities are often viewed as a measure of business health. Financial ratios are one of the main things examined when discussing loans or possible business transactions. Liabilities are not only connected to day-to-day operations for accounting purposes but are incredibly important to lenders and investors.
Loan covenants carry various restrictions, and a considerable liability on the balance sheet can potentially push you out of compliance with lenders. In addition, buy and sell transactions can also be affected by liabilities on the balance sheet, so both parties must understand the type of liabilities present.
Adhav recommends getting ahead of the process by contacting lenders, lawyers, and accountants to determine the impact this change will have on your business.
Although it is overwhelming to think about changing accounting processes, here are four steps to help you get to ASC 842 compliance.
Step 1: If you already follow ASC 840, consider the current accounts on your balance sheet that need to transition to ASC 842. Make sure you have your amortization schedules solidified and find out if your accounting cycle is a twelve or 13-month cycle. Make sure to consider your accounting periods through the lease expiring furthest into the future. You need to incorporate this information to forecast your leases, including any year-end resets going forward for ten, twenty, or more years.
Step 2: Evaluate if you have any upcoming audits, loans, or other transactions. Opening a conversation with your auditor is crucial so you can plan appropriately. While ASC 842 is a detailed standard, many nuances are still up for discussion concerning the practical application, even among the Big Four accounting firms. Besides your auditor, your lender needs to understand your policies to ensure you comply with loan covenants. Also, participants of any other significant business transaction should understand how ASC 842 affects the balance sheet.
Step 3: Solidify your crucial policy decisions. For example, decide what rate you want to use for the NPV calculation. Will you use the incremental borrowing rate, risk-free rate, or imputed rate? Many choose the risk-free rate, although some pick the standard imputed rate. The rate determined is one of the topics you need to discuss with your auditor. “Many people say, ‘you know what? We’re going to use a standard rate of X percent that’s imputed,'” Adhav said. “But you don’t want to get into the system of looking at each imputed rate across every lease because it’s going to cost you a lot of money.” Another critical policy to resolve is the preferred adoption date. A popular choice is January 1, 2022, although some have selected a year earlier. Once again, this is why it’s so important to have these discussions with your CPA.
Step 4: Look at material transaction components. Review whether your transactions have tenant improvement allowances and where you stand in applying them. Consider if you have lease repayments, early access, rent abatements, transaction fees, renegotiations, or early terminations. All of these items need to be considered when transitioning to ASC 842 and brought to your accountant’s attention.
As daunting as it may be to organize all of this information to transition to ASC 842, you can turn to Leasecake for help. Where spreadsheets fall short, Leasecake offers a multidimensional solution for tracking your lease details with effective technology integrated with a strong team.
Leasecake allows your accountants, lawyers, and lenders to access your data for multiple location leases through one access point. Not only does Leasecake keep your data organized, but we help you comply with ASC 842 requirements and provide helpful reminders regarding critical dates and other items you may want to track.
Schedule a free consultation to see if Leasecake is the right fit for your business, and we’ll review your lease management needs.
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