Private Companies Adoption of ASC 842 – The Future is Now
The deadline for private companies to implement ASC 842 was delayed from the original date of December 15, 2019, to be effective for fiscal periods beginning after December 15, 2021. For calendar year-end companies, this will be effective on January 1, 2022. The delay for private companies was largely due to feedback from public companies on their struggles with implementation and to provide companies accounting relief during COVID.
Adopting the new rules is required for audited GAAP financial statements that are relied upon by lenders and other stakeholders and can have an impact on borrowing and cash flow for companies. The standard eliminates the loopholes with off-balance sheet operating lease obligations and enables users of financial statements including lenders and other stakeholders to accurately assess a company’s performance.
For companies planning an IPO, merger, acquisition, or any other major transaction in the near future, ASC 842 readiness is critical in order to complete related audits and due diligence reviews.
Summary of ASC 842
The key change under ASC 842 is that substantially all lessee leases are now required to be recognized on the balance sheet as a Right of Use (ROU) asset with a corresponding lease liability. An exception to this is that an election can be made for leases with a term of 12 months or less to not record on the balance sheet and to recognize lease expense on a straight-line basis.
In order to help companies more easily adopt the new standard, ASC 842 allows for the election of various practical expedients during the transition. Some of the more common expedients include:
Hindsight practical expedient – This allows the use of hindsight in determining the lease term and assessing impairment.
The package of practical expedients – The three expedients within this package must be elected together and applied consistently to all leases. The expedients allow for a company to not reassess the lease classification for any expired or existing leases and to maintain its original classification, to elect not to reevaluate whether expired or existing contracts contain an embedded lease, and to not reassess initial direct costs.
Land easements – a practical expedient to not reassess certain land easements.
A lease is a finance lease if the lessee effectively obtains control of the leased asset, otherwise is considered an operating lease. Operating leases over 12 months are recorded on the balance sheet and rent expense is recorded on a straight-line basis. Finance leases will not require remeasurement at transition; the interest on the lease liability and amortization of the ROU will be recorded in separate lines on the income statement. The discount rate for the lessee is the rate implicit in the lease unless that rate cannot be readily determined, then the incremental borrowing rate should be used.
Lessor leases under ASC 842 more align with ASC 606 (Revenue Recognition). Initial direct costs of a lease under ASC 842 are defined as increment costs of a lease that would not have been incurred if the lease had not been obtained. For a lessor, the discount rate is the rate implicit in the lease.
Lessons Learned from Public Entities
As public companies have implemented ASC 842, some common issues on implementation have emerged. Overall, most companies have indicated that the implementation takes much longer than initially anticipated. Gathering leases and identifying embedded leases is challenging particularly if there is not a centralized repository for leases. Additionally, the investment of resource time required is more often underestimated. Many companies recommend considering outsourcing to ease the pain of the implementation on already stretched internal staff.
What steps should be taken
It is essential to have a detailed plan with a timeline, tasks, and deliverables for every step of the process. Determine if present staffing levels are sufficient and knowledgeable to oversee and perform the project work. If not, hire consultants to assist in the process. Involve all departments in the company to identify contracts with any potential embedded leases. Decide on practical expedients and the policy elections available in the accounting guidance. Consider whether lease accounting software will be needed to calculate right of use assets, lease amortization schedules, and disclosure requirements. If so, evaluate and purchase lease software without delay in order to have time to implement, test, and validate calculations.
Review and update internal controls to address inherent risks in lease accounting.
Bridgepoint can help
In order to perform related audits and due diligence assessments, ASC 842 preparedness is crucial for organizations planning an IPO merger, acquisition, or any other big transaction in the near future. We have a team of Finance and Accounting experts here at Bridgepoint Consulting that can help. Reach out today.