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ASC 842 Adoption for Private Companies. Act Now on the New Lease Accounting Standard

asc 842 lease accounting standard

 

The Financial Accounting Standards Board (FASB) issued ASU 2016-02, Leases (Topic 842), referred to as ASC 842, in February 2016. The most significant differences between the new lease accounting standard and previous GAAP are: 

  • The recognition by the lessee of operating lease assets and liabilities on the balance sheet. 
  • Increased disclosure requirements of leasing arrangements.  

The FASB has twice deferred the effective date of ASC 842 for private companies, and, in November 2021, unanimously rejected a third deferral request of ASU 842 for private companies. Most public companies with calendar year-ends already adopted ASC 842 for annual periods on Jan. 1, 2019.  

Private companies with calendar year-ends – i.e., Dec. 31 – are required to have adopted the provisions of ASC 842 effective Jan. 1, 2022. The adoption and implementation of ASC 842 can take longer than initially anticipated. Don’t be surprised and don’t let the adoption and implementation of ASC 842 delay your 2022 year-end closing and other requirements such as issuance of audited financial statements.  

What Should Private Companies Be Doing Now?  

Start with identifying the lease landscape.  

For example, how many entities within the consolidated group have lease arrangements or other contracts that could contain embedded leases? Consideration of whether lease arrangements are centralized or decentralized could have a bearing on the extent of effort in identification of lease arrangements.  

The identification of lease arrangements entails not only contracts explicitly designated as lease contracts but also other non-lease contracts that contain leases within them (embedded leases).  Beyond identifying the inventory of leases, also consider the nature and type of leases, such as real estate and copier leases or increased diversity and complexity of leases in the portfolio. 

The evaluation of lease landscape will inform the assessment of the size of project team, extent of use of external consultants, and lease tool software considerations. For instance, to the extent a company has a handful of plain vanilla leases, it may be able to use Microsoft Excel or similar tools to manage the accounting for leases.   

However, to the extent the lease population is large and diverse or expected to grow, a company may consider a lease software tool. Companies should consider not only the adoption of the new lease accounting standard but also the effort and resources necessary for ongoing reporting requirements. 

In other words, don’t underestimate the “Day 2” accounting and reporting requirements and the associated systems and processes necessary to capture the required information. 

OK, I Have a Sense of My Lease Landscape. What Next? 

Companies may start by extracting necessary data and information to identify and account for lease arrangements relative to their unique circumstances. 

For example, certain arrangements may be in entities operating in foreign countries where contracts are in foreign languages and contain provisions not typical in the United States. It will be necessary to extract required information to account for lease arrangements such as, but not limited to: 

  • Key dates. 
  • Lease term. 
  • Renewal provisions. 
  • Variable payments. 
  • Termination clauses. 
  • Rights to asset conveyed. 
  • Amendments. 

In aggregating the required information, one might consider not only capturing the information necessary for initial accounting but also that which might be necessary to comply with the increased disclosure requirements on an ongoing basis. 

What Are Some Items I Should Consider and Watch Out For? 

Following initiation of the new lease accounting adoption and implementation project, such as evaluation of lease landscape and extraction and capture of necessary information, companies should consider some of the following additional items: 

  • Evaluate and select the ASC 842 transition method (i.e., effective method or comparative method). Under the effective method, the new lease accounting standard is applied as of the effective date, while prior comparative periods are presented under ASC 840 (lease accounting standard prior to ASC 842). Alternatively, under the comparative method, the prior comparative periods presented are also reported under ASC 842. 
  • Consider and identify any sublease arrangements. 
  • Lease classification considerations (i.e., criteria for capital vs operating leases). Determination of a lease arrangement between operating and finance lease classification can affect the accounting treatment, financial statement classification, and disclosure requirements. 
  • Evaluate and elect practical expedients available under ASC 842. Certain practical expedients are required to be elected as a package (primarily related to transition) while others can be elected individually – for example, the short-term lease (less than 12 months) exemption. Practical expedients are intended to reduce the burden of implementation of the new lease accounting standard.  
  • Consider use of incremental borrowing rate or risk-free rate (practical expedient available to private companies) to discount the lease liability. While the use of the risk-free rate reduces complexity, it generally results in a higher lease liability and corresponding lease asset compared to that based on an incremental borrowing rate. Further, once elected, it will have to be applied across all leases. 
  • Establish ongoing processes and controls to identify, capture, account for, and prepare required disclosures for leases on an ongoing basis. 
  • Consider impact to income tax attributes of the new lease accounting standard. 
  • Consider impact of the new lease accounting standard on the company’s debt covenants and financial ratios. Companies should carefully evaluate the provisions in their credit agreements. 
  • Calculate and record journal entries for ASC 842 adoption on effective date as well as journal entries for the period immediately following effective date (for example, for fiscal year ending Dec. 31, 2022 for calendar year-end companies adopting ASC 842 on Jan. 1, 2022). 
  • Capture information for and prepare the required financial statement disclosures pursuant to the new lease accounting standard. ASC 842 increases the required disclosures in the notes to the financial statements.  

Though not an exhaustive list, these circumstances are applicable to most companies. 

For expert implementation support of ASC 842, contact CrossCountry Consulting today. 

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