Adopting ASC 842 Lease Accounting is Not an Option: Jump Start the Process Now

An integral part of managing the operations of a business is making decisions of whether to lease or buy equipment, buildings, and vehicles. While you may have found those decisions easy to make, additional business practices must now be implemented to conform with current accounting standards.

In 2016, the Financial Accounting Standards Board (FASB) issued its Lease Accounting Standard, ASC 842 (Accounting Standards Codification). Public companies were required to adopt the standard beginning in late 2019 and while the initial implementation date was deferred due to the pandemic for others, non-profits and privately held businesses who have fiscal years beginning after December 15, 2021, must now follow the guidance of the ASU (accounting standards update) for annual reporting. Beginning December 15, 2022, all organizations must follow the standard for interim reporting as well.

“The new standard will require organizations that lease assets— referred to as “lessees”—to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases.”

  • – Financial Accounting Standards Board

What Is the New Lease Accounting Standard?

The new lease accounting standard requires that businesses transition from recording operating leases as direct expenses to creating journal entries that record the obligation of the business to the lessor as a liability on the balance sheet and then documenting the reduction of the obligation as lease payments are made over the duration of the lease term. An asset will also be recorded as a Right of Use Asset to show the business has contracts in place to utilize the assets to support their business.

The process of including operating leases on the balance sheet is intended to promote greater transparency to financial statement readers so they have the additional knowledge to make better decisions regarding the organization.

BKMSH

What Qualifies as a Lease?

Businesses must conduct a thorough review of their contracts and other records to ensure that all leases are captured and properly recorded. The FASB identified three primary criteria in the new standard for what would be considered a lease.

  • It must be a physical asset
  • You must have the right to control or use the asset
  • The asset must be explicitly or implicitly defined

While the criteria may seem clear, there are several situations where judgment is required to properly account for all leases. Leases are often embedded in contracts that include service components or there are there is a portion of the costs that are variable, such as a retail site that includes a base amount plus a percentage of sales.

Implementation Complications

Business owners and managers should anticipate spending a considerable amount of time identifying potential leases, capturing all the data elements of each lease (start and end dates, amounts due at what intervals, etc.), and in recording and maintaining the accounting transactions needed for ASC 842 compliance.

Debt Covenants

As with other accounting method changes, adopting ASC842 will affect your financial results as you integrate your operating leases into your balance sheet. The degree of the change will vary by company but those with significant lease liabilities should be aware that it could impact your compliance with debt covenants. If that is your situation or you believe it could be, you should begin conversations with your bank as soon as possible to address the situation.

Policy Elections

The new lease standard requires organizations to make policy decisions about how leases are handled. This will include deciding whether or to not adjust comparative periods retroactively, the handling of short-term leases, and whether to adopt a portfolio approach, among other items.

You and your team will need to determine the implicit rate for leases, prepare required disclosures and identify and manage asset impairments that could occur under the new lease standard.

Taking Action: Your Next Steps

The sooner you begin working on adopting the lease accounting standard, the better the process will be.

  • Assign a team responsibility for completing the ASU implementation. This isn’t a process that you can let fall through the cracks.
  • Determine the scope and complexity of your lease portfolio. This is particularly relevant if you have multiple locations or decentralized management of leases currently.
  • Develop a work methodology to process and assess existing leases and integrate new leases that are contracted.
  • Review and understand what policy decisions need to be made, model their impact on your organization, and make the selections.
  • Track this implementation as a project with assignments and deadlines to ensure that it is completed in a timely manner to stay in compliance.

And the final step—ask for help if you need it. BKM Sowan Horan, LLP has the knowledge and resources to assist you with your implementation of ASC 842. We can help you conduct the review process, evaluate the policy decision options for your organization, and offer a technology solution to make the implementation and ongoing lease accounting work accurate and efficient. Our goal is to simplify and streamline the lease accounting implementation process for your organization and we welcome the opportunity to discuss it with you and your accounting team.