Leases on the balance sheet: ASC 842 is here

By Genevieve Hancock, CPA

During the pandemic, ASC 842, the lease standard for private companies, was delayed to a 2022 implementation deadline. Even though private companies have had since the standard’s release in 2016 to prepare, a large population of companies are still not fully ready or have not implemented the new lease standard.

The lease standard is not new for public companies; it was required for implementation for interim periods beginning after Dec. 15, 2018. One of the key takeaways from the process was to not wait until the very last second. Data gathering and review takes a long time for this implementation — in some cases, this has been a larger undertaking than the revenue recognition standard depending on the size and composure of the organization.

This article will mostly concentrate on best practices for small companies from a project management perspective around implementation, but first let’s refresh our understanding quickly on the lease accounting changes.

Summary of lease changes

Why is the accounting for leases changing? Simply put, because leases are one of the last long-term liabilities, and correlated rights-to-use the asset under lease, which are not always accounted for on the face of the financials. Everyone has heard how all leases are going on the balance sheet now — not just capital leases as under ASC 840 (the prior lease standard).

We will mostly concentrate on the lessee position within the article, as lessor accounting was largely unchanged. Operating leases will now be accounted for on the balance sheet as a lease obligation and a right-to-use asset. Finance leases, previously known as capital leases, will be accounted for in a similar way as under the prior guidance. The key difference between the two treatments on the income statement will be that the difference between the liability (which is present valued) and the cash paid will be booked to interest expense. 

Project management

This cannot be emphasized this enough: Start early with data gathering. Not all lease signature or real estate processes have been centralized within private, or even public, entities. Take a step back and think about the existing data. In many cases, a commitments and contingencies schedule is a required footnote within private financial statements. This is a great place to start to look for leases for assessment. Other key areas are to review the rent expense detail and deferred rent balance sheet detail, and the audit support provided to your auditors for straight-line rent expense. Often over-looked leases include equipment leases, vehicle leases, and sometimes even smaller building leases. These will likely require partnership with departments and individuals across the company to identify in order to ensure completeness of the lease listing for transition.

Ensure that you have identified all key stakeholders, have briefly trained everyone that touches a lease in the process of being signed, and have implemented controls around the process to ensure that both the accounting is correct and that the lease contracts get to the correct professional to be accounted for under ASC 842. The legal department may be a key partner to this update, as many organizations have requirements for lease or real estate contracts to be reviewed by internal legal counsel. If your organization does not have this process set up, and does not have a real estate finance department, then discuss with procurement and sourcing departments to understand the contract review process and identify key signers and what the thresholds for signing are. Authorized signing criteria can be either position-based or amount based.

Make sure that the continuous improvement around this process of data gathering and key stakeholders continues as you move forward. New amendments, early terminations, and new leases after the transition also need to be considered for ensuring the information gets to the right place.

Takeaways from implementation

Private companies can learn from some of the challenges and difficult implementation areas experienced by public companies that have already tackled the lease standard.

One of the more difficult and complex considerations under ASC 842 is the concept of an embedded lease. ASC 842 changed lease accounting to a more principles-based approach, rather than the rules basis that most accountants who use U.S. Generally Accepted Accounting Principles (GAAP) are used to operating under.

Under the principles-based approach, we look at the substance of the transaction and not the legal terminology within the contract — for example, a contract can say “revenue contract” as a title, but as long as the counter party gets access to a tangible asset and has the right to direct the use of that asset for a specified period of time in exchange for consideration, then this is really a lease contract based on the principle. Embedded leases are the right to use and direct the use of an asset that is embedded within another type of contract — vendor agreements, IT service contracts, revenue contracts, or any type of other contract.

There are a few key places to look for embedded leases. Inquire with different departments to find out whether there are any tangible assets or personal protective equipment that your company gains access to through a contract. IT and printer service agreements are common areas in which embedded leases are normally found. If your company is paying for data retention services, and within that IT service contract a specified space on a server (and you can identify that specific server), then that contract needs to be assessed for whether that embedded lease needs to have an allocation to rent expense.

Another takeaway that has been common across public company implementations are the systems, tools and outsourcing of lease tracking projects. Organizations and financial systems for ASC 842 are abundant — whether hiring in a consultant or firm to assess and document the lease change for the organization or signing up to outsource the accounting and then reviewing internally prior to booking adjustments. Certain systems also have integration or modules within your existing enterprise resource planning (ERP), which can be turned on the account for the leases. Make sure that the individuals reviewing and inputting the data have been fully trained on both the system and the updates to lease accounting prior to starting to use the system of choice.

Amendments and special considerations    

While the International Accounting Standards Board’s IFRS 16, effective for periods on or after Jan. 1, 2019, and ASC 842 are very close in changes, there are still differences between the two standards. If there are statutory reporting requirements outside of the United States that need to be considered, then make sure the reporting differences under the new standards are understood and adjusted for — or at minimum, documented that they are immaterial in total if that argument can be made.

One of the amendments issued after the standard change had been announced is the impact on easements. A right-of-way or easement needs to be assessed for lease accounting if there is consideration (generally cash) transferred for that easement. Luckily, there is a practical expedient to make this easier as you can elect prior accounting for easements, but your organization must make this election for all easements within the portfolio.

Additional special considerations for lease accounting transition that will require additional attention include subleases, sale leaseback transactions (both existing and new), and existing leveraged leases.

Private company elections

During 2021, one very positive amendment issued by the Financial Accounting Standards Board in relation to ASC 842 was the option for private companies to elect to use the risk-free rate in order to cut the burden of costs related to 842 implementations for small companies. The election of this rate eliminates the time-heavy burden of determining the rate per lease or any updates to the rate when attempting to calculate the present value of minimum lease payments around the transition of operating leases.

Conclusion

First, if your company is subject to the new lease standard implementation, which it likely is, start your assessments now. Data gathering, training and documentation can all take a lot of time and effort from both accounting and other departments. Leverage existing processes to gather data prior to creating a separate one, but keep in mind that you will likely have to set up new processes to manage new information going forward. If your company does not have quarterly reporting requirements under GAAP, you may have some additional time but that does not mean that your organization should put off the implementation until the last possible second.

Second, ask for support — whether that is in the form of an additional ERP lease module, a separate system, or entirely outsourcing the lease transition process to consultants. There is assistance out there with experts in the field who have now had years of practice to hone their abilities since the 2019 transition for public companies.

Third, ensure that you train all individuals touching leases in your organization around the updates to the standard that are relevant to their areas, tailor the training to the audience, and ensure that they know who to contact with questions.

This transition may not seem like a lot of differences from an accounting perspective for implementation, especially after many of us remember the horrors that came with ASC 606 — Revenue from Contracts with Customers. For project management and data gathering exercises, it can be a lot more than 606, and extremely time consuming.

Genevieve Hancock, CPA, is the global corporate controller and chief accounting officer for Exactech, Inc. Genevieve began her career in internal audit and public accounting, and moved into technical accounting specializing in accounting policy, compliance, and implementations of accounting standards for both private and public companies. She is passionate about developing technical accounting, research, and leadership in colleagues. She is currently on the VSCPA Young Professionals Advisory Council, the Disclosures Editorial Task Force, and the Center for Innovation Advisory Council.