ASC 842 is a radical transition of accounting rules for companies of all sizes. Equipment, real estate, and other asset operating leases have historically been structured as long-term rentals. As such, balance sheet capitalization of these leases hasn’t been required. However, with the transaction recorded only as an expense on the balance sheet, there was a transparency issue regarding real asset and debt levels. To correct this, ASC 842 requires the capitalization of all leased assets on the balance sheet.
Public companies began implementing ASC 842 in early 2019. For private companies, ASC 842 was previously scheduled to take effect for annual financial reporting periods beginning after December 15, 2019 (2020 for year-end calendar companies). With an accounting change of this scale, public companies spent years preparing for the new standard, requiring a significant allocation of resources to ensure compliance. As the change began to make its way to the desks of accountants and auditors at mid-sized and smaller companies, it became evident that smaller firms were unprepared.
Recognizing the challenges faced by businesses without the dedicated accounting staff and internal resources to quickly effect the changes required by ASC 842, the American Institute of Certified Public Accountants and various other organizations lobbied the Federal Accounting Standards Board (FASB) to delay implementation. Reasons cited for the delay included struggles public companies have experienced with adopting and complying with the new lease standard and the ongoing implementation of the FASB’s new revenue recognition standard.
With the deferral, private companies will be required to adopt ASC 842 for annual financial reporting periods beginning after December 15, 2020 (2021 for year-end calendar companies).
Will This Change Affect You?
Since capital leases have been treated as traditional debt for some time by GAAP, most smaller companies may already be capitalizing their leases. These capital leases require transfer of ownership, while ownership of operating lease assets remains with the lessee. If you have capital leases, this process will be more an administrative effort of complying with the new reporting provision as opposed to a massive change in your company’s financial statement.
Either way, ASC 842 will affect most American companies in some way.
- Gather stakeholders. Since ASC 842 may have tax implications and because leases may be signed and managed by different parts of your team, ensuring all stakeholders are assembled is critical. IT, tax, operations, warehouse management, real estate, and legal are just some of the specialties businesses need to make sure are represented when addressing preparedness.
- Identify all leases. Be careful not to underestimate this one. Identifying all your leases can be a tedious process. Make sure to include all your long-term rentals (over 12 months), if that applies to your business, and work with your team to understand which leases are considered as operating (off balance sheet) and capital (on balance sheet).
- Review data collection and management. Existing lease management systems may not provide all the information needed to make calculations, judgments, ongoing assessments, and disclosures. Businesses need to verify that data collection systems are in place to ensure easier compliance.
- Update IT systems, processes, and controls. Today many companies use spreadsheets to track leases and prepare required disclosures and accounting evaluations. Given the comprehensive accounting and disclosure requirements of the new standard, companies will likely need to supplement their current IT systems or implement new IT systems to comply.
- Understand financial metric impacts. Banks may evaluate your lending capacity based on leverage ratios. Bringing operating leases on the balance sheet may affect these ratios and subsequently impact how your banker evaluates you. It’s important to keep an open line of communication with your banker if this results in a material change in your financial statements.
It’s easy to get overwhelmed with the complexities of any change in accounting, tax, or finance rules. LEAF works to make equipment easier to buy and sell. And part of that is working to simplify the issues that surround your ownership of the equipment – including the challenges posed by ASC 842. If you have questions regarding the specific application to your business, we recommend you contact your tax advisor.