If your company, like most, leases equipment, vehicles or other assets, you’ll need to prepare for the Accounting Standards Update Leases (Topic 842) — often referred to as ASC 842. For public companies and certain others, the rule is effective this year. For nonpublic companies, this new lease accounting standard goes into effect for fiscal years beginning after December 15, 2019.
What’s the goal?
The goal of the new standard is “to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements,” according to the Financial Accounting Standards Board (FASB).
To that end, one significant change under the new standard occurs on the balance sheet, which will need to include most lease liabilities with terms of more than 12 months, as well as the right to use the asset identified in the lease throughout its term. Previously, many operating leases weren’t shown on the balance sheet.
If a lease term is for 12 months or less, your company can decide not to recognize the assets and liabilities. Instead, it can recognize the lease on a straight-line basis over the lease term.
For finance leases, you’ll generally need to:
- Recognize a right-of-use (ROU) asset and a lease liability, initially measured at the present value of the lease payments, in your balance sheet,
- Recognize interest on the lease liability separately from amortization of the ROU asset in your income statement, and
- Classify repayments of the principal portion of the lease liability within financing activities, and payments of interest within operating activities, in your statement of cash flows.
The requirements are somewhat different for operating leases. (See “Operating lease requirements.”)
How do you prepare?
Preparing for the new lease accounting standard requirements may be more involved than it initially appears. It’s not unusual for individual departments within a company to enter into separate lease arrangements. Some leases are embedded within larger contracts and not even recognized as leases. Here are some steps to help your organization get ready:
Identify the project leader(s). The leader should possess technical knowledge of the standard. Strong interpersonal skills also are key in this position, because identifying and extracting specific information contained within leases often means working with several departments. Many won’t be familiar with the new standard and might balk at what they view as an imposition. Solid communication efforts can boost overall staff buy-in, increasing the likelihood of success.
Conduct a lease inventory. This may require scouring records, such as copies of service contracts in which leases may be embedded, to identify all possible lease obligations across departments and locations. Given the range of documents across varying systems that can contain leases, such as contracts, invoices and corporate card statements, this step may be largely manual.
Review leases to identify the information to be disclosed. Once you’ve identified the leases, you’ll need to extract and calculate a range of information, such as the present value of lease payments. You’ll also need to designate each lease as operational or finance.
Implement a lease management system. To store and report on your company’s lease obligations going forward, a spreadsheet still can work, especially with a smaller number of leases. But a dedicated lease management solution can streamline this function. Any new solution should integrate smoothly with your other systems and handle leases for different asset types. If your organization is growing, the system should be able to scale with it.
Discuss the change with stakeholders. If the new lease accounting standard will significantly change your financial statements, you’ll want to discuss the impact with users of those statements, including lenders, investors and outside accountants — ideally, before they’re presented with the reports. That way, you can try to minimize surprises and concern.
Maintain compliance. As your organization enters into new contracts and leases, you’ll need to continue to comply with ASC 842. This likely will require developing processes to ensure leases are recorded properly across the company.
What are the benefits?
The work required to comply with ASC 842 can be significant. But it also can offer benefits. With a better understanding of the lease terms in effect, you may be able to leverage economies of scale and more effectively negotiate future leases. In addition, having this information readily available makes it easier to analyze the lease portfolio.
In the past, some lessees would spend time trying to ensure a lease was operational and could remain off the financial statements. Because that’s no longer an option in most cases, everyone can instead focus on obtaining the best value for the organization.