By Josh Harnevious, CPA
As public companies were required to implement the Financial Accounting Standards Board’s (FASB) new standard on leases, Accounting Standards Codification (ASC) 842 Leases beginning January 1, 2019, the financial statement impacts of the standard have become more clear in quarterly reporting for SEC filers. In short, lessees are now required to recognize virtually all leases on the balance sheet by recording a right-of-use asset and a related lease liability.
If your company leases anything- from office space, warehouses, server space, a fleet of trucks, or even just a few copiers- you’ll need to consider the effects of this standard on your financial reporting.
Recent surveys of organizations who have adopted ASC 842 indicate the adoption of this standard creates difficult implementation challenges to ensure completeness of the lease population and related data, and a significant use of human capital resources throughout the adoption period. As many private companies are still working through the implementation of the new revenue standard, ASC 606 Revenue from Contracts with Customers, considerations and planning for ASC 842 have taken a back seat.
Therefore, because of the challenges facing private companies, on July 17, 2019 the FASB issued a proposal delaying the effective date of ASC 842 for an additional year for private companies, meaning, if approved, the adoption of the standard would not be required until January 1, 2021.
While the delay in adopting ASC 842 one more year would be beneficial to private companies, more time to implement doesn’t necessarily mean that you can or should ignore it for another year.
Managing the Transition
Compiling the information necessary to properly record leases under ASC 842 will take planning, careful analysis, and time. Here are five things you can do now to make the transition easier:
- Create an accounting policy to identify short-term leases – leases of 12 months or less may be exempt from recognition requirements, if the company elects the short-term lease exemption.
- Compile an inventory of all leases – as the new lease guidance requires recognition of a right-of-use asset and lease liability for the vast majority of lease transactions, it’s important to be sure that you’ve compiled a complete list of all leases. There may even be portions of service contracts or implied leases in other agreements that need to be considered which haven’t been previously classified as leases under legacy generally accepted accounting principles.
- Document all relevant lease terms in a central database – information such as a description of the asset, terms of the lease, discount rate (if implicit), payment schedules, renewal options, and more will be necessary for evaluating the classification of the lease and determining the amounts required to be reflected on your balance sheet. You should also examine lease agreements for amounts such as service or maintenance components that might be excluded from the amount to be recorded on the balance sheet.
- Develop a policy for tracking new leases or changes in existing leases – compiling all the information on your current leases is a critical step, but maintaining the list is critical to being prepared for adoption of the standard. Make sure that you have processes in place to consistently identify and document new leases, as well as to evaluate and document renewals or modifications of existing leases.
- Examine lending agreements for covenants that may be impacted by the change – debt covenants may include maintaining certain financial ratios or other criteria that could be directly impacted by the “new” lease liabilities on the balance sheet. Talking with your bankers now to understand how they view these potential changes may help avoid covenant violations
Given the scope of the changes in the leasing standard, being prepared for implementation by doing these things in advance will be of tremendous value whenever the lease standard becomes effective.