What Private Companies Need to Know About Lease Accounting Under ASC 842
In July, the Financial Accounting Standards Board (FASB) voted to delay the effective date of some of its major accounting standards, including ASC 842, lease accounting, for privately-held companies, nonprofits, and small reporting companies.
The delay gives those organizations an extra year — until January 2021 — to adopt the new lease accounting rules and manage the disruption such accounting changes cause. Frankly, it’s additional time that many private companies sorely need.
Earlier this year, the lease accounting software provider LeaseAccelerator surveyed 350 finance and accounting leaders from US-based private companies with $1 billion or more in revenue. They found:
- Only about 12 percent of private companies have completed their ASC 842 adoption project
- Approximately 40 percent are behind schedule or haven’t started the project
- The remaining 48 percent indicated they were on or ahead of schedule
Since public companies have already implemented the new standard, private companies can benefit from their lessons learned during implementation.
An Overview of ASC 842
ASC 842 moves the measurement of operating leases from the footnotes of GAAP financial statements to the balance sheet, closing the off-balance sheet operating leases loophole in the previous standard, ASC 840.
That loophole allowed companies to omit certain lease assets and liabilities from their balance sheets, potentially skewing their debt-to-equity ratio and making it difficult for shareholders, investors, and lenders to get a real sense of a company’s financial health.
Under ASC 842, the only leases that may be omitted from the financial statements are short-term leases with an original term of fewer than 12 months. This change is designed to provide a clearer picture of an organization’s leasing obligations.
Best Practices for Adopting ASC 842
Implementing ASC 842 poses a significant challenge for many private companies. Here are some proven approaches to implementation.
Involve Your Entire Team
Implementation of ASC 842 is primarily the responsibility of your organization’s accounting department, but successful implementation requires support from across the firm, especially if your company has a large real estate portfolio or embedded leases — those leases that included within service agreements or other contracts.
In companies where multiple parties within an organization have the authority to enter into a leasing arrangement, the accounting team may need to work closely with IT, legal, procurement, and other departments.
Many off-the-shelf technology solutions that can help with ASC 842 transition and compliance. If your organization has a large number of documents to assess under topic 842, consider using machine-learning or artificial intelligence software specifically designed to analyze legal documents. This technology can significantly speed up analysis and reduce overall costs.
However, be sure to test-drive new software solutions to see how well they work with your team and interface with your current technology stack. Because many of these solutions are relatively new, there may still be bugs that need to be worked out.
Consider Communications with Stakeholders
With organizations now required to include operating leases on the balance sheet, your company may appear to be more highly leveraged, even though income statements are not affected. Consider how such significant adjustments to the organization’s financial statements will be communicated to stakeholders with a financial interest in the company.
Also, consider how the change may affect loan covenants. Reach out to lenders to discuss whether you may need to modify existing debt arrangements. Transparency is critical, so be proactive about keeping stakeholders well-informed throughout the transition.
Don’t Delay Implementation
Complying with ASC 842 is a time-consuming process that involves identifying and reclassifying lease commitments and may require collecting necessary data from external sources.
Don’t let the delayed effective date lull your organization into inaction. Develop an implementation timeline that factors in assessing existing leases, coordinating across the organization, gathering required documentation, develop new or updated systems and controls to identify embedded leases in new contracts and agreements, and keeping stakeholders informed.
Reduce the burden of implementing the new lease accounting standard by leveraging lessons learned from public company implementation. Many public entities reported that implementing ASC 842 was more challenging and costly than anticipated. The delayed effective date will be upon us soon enough. Begin the planning and implementation process now if you’ve not yet started.