On June 3rd, 2020 the FASB met to decide on whether to delay the effective date for lease accounting for private companies and nonprofits. The proposal to delay the date, first brought to the floor over in April, seeks to offer companies relief from the sudden disruptions caused by COVID-19.
The FASB proposal was approved, making the new effective date for those companies January 1, 2022. This update only impacts domestic leases for domestic companies reporting under the FASB guidance. Accordingly, any lease that is outside of the United States will most likely need to comply with the new standard according to the IASB guidance and effective date.
LeaseQuery conducted a survey in 2019 and found that 58% of private companies say they are in the beginning stages of adoption. Whether you’re in the early stages or you have yet to get started, don’t let the extended deadline lull you into a false sense of security. Use the additional time wisely.
There are a number of things you must do in order to transition to the new standards, and the process is more difficult than you think. In our recent survey, we found that 50% of respondents in the early stages anticipated the transition to be neither easy nor difficult. Companies who are further along in the transition process, however, have a different opinion. 67% percent found the process to be difficult. This may be due in part to the number of steps you must take to transition, which are listed below.
1. Start building an inventory of your leases
Completeness of your lease inventory is a crucial component of the compliance picture. We gave guidance on how to develop a comprehensive lease inventory in this blog. To quickly summarize, you’ll need to work with numerous departments across the company, so you need to look at your requisitions process to determine which departments contracts are funneled through. From there, you’ll need to document each lease and its pertinent details in a template. This is an organizational cultural change of centralizing a practice that has often been done in a decentralized manner in most companies.
2. Begin gathering your embedded leases
As part of your lease inventorying process, you will also need to compile your embedded leases. Embedded leases are commonly found within service agreements, so it is likely that your existing service contracts will need to be reassessed.
There is a practical expedient that says you don’t need to re-evaluate expired or existing contracts. However, this assumes you haven’t made any errors in your current assessment. In order to be sure, you will still need to reassess your contracts.
If you’re struggling with gathering your embedded leases, you’re not alone. Many companies are overwhelmed by this process. There are some common types of contracts that contain embedded leases, which you can use as a starting point:
- Security contracts often contain leases for equipment, such as scanners or monitors
- Logistics and transportation agreements may contain language that identifies a specific vehicle to be used solely for your needs
- Data center contracts may designate specific servers for your company, which could amount to a lease
To help you identify your embedded leases, we offer a free interactive embedded lease test that you can use to determine if your contracts contain leases:
3. Prepare for the calculations you need to make
There is a complex set of calculations you have to complete in order to be fully compliant. Beyond net present value, you also need to calculate:
- Lease liability amortization schedule
- Right of use asset amortization
- Straight line rent expense
- Amortize right of use asset and liability balances over the lease term
- This is driven by the discount rate. Learn more about incremental borrowing rate and discount rate here.
- Liability reduction
- Asset lease expense
- Weighted average discount rates for operating leases
- Weighted average lease term for operating leases
- Weighted average discount rates for finance leases
- Weighted average lease term for finance leases
4. Start evaluating software
ASC 842 lease software will save you an immense amount of time, but it does take some upfront legwork to get the right solution up and running. If you’re weighing whether or not to start now, consider how you’ll benefit from an early start:
- Give yourself time to thoroughly evaluate your options and find the best one for you
- Reduce stress during the implementation process
- Be comfortable using the software well before you need to pull your first post-transition journal entries and reports
- As you gather leases, you have a centralized location to store them in
This extra time allows you to properly vet lease accounting software solutions and select one that meets your needs. While the new deadline has not officially been disclosed, finding the right software and transitioning to the new standards requires a lot of time and due diligence. We cover the steps companies need to take to transition in more depth in our transition guide:
1. Being proactive will help you avoid pitfalls public companies faced
As previously stated, 67% of the companies we surveyed found the transition process to be a difficult one. Part of the reason is that many of them planned to and often did transition with Excel. Not only did this increase the amount of time they took to enter their leases, but it often left them with doubts about its accuracy.
2. You could be catching errors now
Many companies have horror stories about their experience using Excel for their lease accounting. One of our clients stated that tracking their leases in Excel resulted in a $648,000 overpayment on one of their leases. The inability to set up a trigger to notify the accounting department that rent should have been fully abated on every anniversary of the lease led to a steep fee. Another company lost over a $2 million Tenant Improvement Allowance (TIA) after they realized during the acquisition process that their TIA was not transferred because there was nowhere in Excel to capture that information. A study conducted by Robert Half found that 90% of CFO’s surveyed planned to change the lease accounting solution that they originally decided on.
3. You could be forecasting and budgeting better now
Being proactive means more than finding the right software. It sets you up for the ability to forecast on your leases, so you can identify how much money you will spend on your leases in a given period, as well as how much you’ll spend by a particular region, department, or business division. Using anything other than a lease accounting software means a lot of extra work and heavy lifting to calculate the above. It’s important to find a lease accounting solution with custom reporting features so you can create a report based on any allocation or segment you need. That way, you can be an expert in the room as your colleagues need information about leases.
Imagine if FASB had not delayed the effective date and you have not begun your transition? In addition to your day job, there are several things you must do for adoption, including:
- Go through two budget cycles
- Go through several quarter-end closes
- Go through one year-end close
- Go through one year-end audit
- Evaluate software to support the new standard
- Choose the right software to support you
- Implement the software
- Input all the supporting information
- Get trained on the software
- Test the results of the new software
- Be ready for all the transition reporting and accounting
While adopting the new standards seems like a massive undertaking, the best thing to do is just start. Having this extra time is a gift. No matter where you are in the adoption process, we advise you to keep going.
If you liked this article, leave a comment below with your thoughts and read these other informative blogs on accounting under ASC 842:
- Summary of FASB ASC 842, IFRS 16, and GASB 87, the New Lease Accounting Standards
- ASC 842 Disclosure Requirements: A Detailed Example and Explanation
- Operating Lease Accounting under the New Standard, ASC 842: Full Example and Explanation
- Right of Use Asset and Operating Lease Accounting under ASC 842: Full Guide and Example