Private companies can learn from public company implementations of the lease accounting standard

It won’t make a sound. No tremor will be felt. But by the end of this year, as much as $3 trillion in lease liabilities will have landed on the balance sheets of our nation’s public companies.

The trigger? Accounting Standards Codification (ASC) Topic 842, the Financial Accounting Standards Board’s new standard on accounting for leases.

ASC 842 changes the way companies across all industries account for their leases. The new rule aims to provide investors with a clearer picture of what companies owe through their lease obligations — including those for equipment and real estate. For public companies with calendar year-ends, ASC 842 went into effect in January 2019. In February 2019, nearly half of public company executives Deloitte polled said they saw no slowdown ahead in the time and effort to be spent on compliance.

Even so, many had a good idea of what they were dealing with. As a result, the public company implementations of the first major update to lease accounting in nearly 40 years has yielded a number of takeaways that can benefit private companies. Here are some of the highlights.

Lease contract, close-up
Lease contract, close-up

1. Not every lease is clearly labeled “lease.”

Leases can be embedded in many different kinds of contracts, and they aren’t always labeled or defined within those contracts as “leases.” Dedicated servers for cloud computing, railcars for freight shipping, billboards for roadside advertising — the list goes on. In essence, if an agreement conveys the right to control the use of a specified asset over a period of time in exchange for consideration, it may be a lease — even if it’s just part of a broader contract for other goods or services.

2. Leases can be all over the organization.

When public companies began the transition to ASC 842, many of them discovered leases across numerous departments, business units and office locations. People had been keeping track of them in various administrative systems, intranet sites and desktop spreadsheets. The documents themselves could be stored as images, searchable PDF files or even hard copies. In other words, it took considerable detective work to identify a full population of leases.

3. Lease data requires considerable judgment to parse.

Under ASC 842, companies have to keep track of critical dates, payment amounts and other relevant information about the right of use that a contract conveys. These provisions can get complicated; multiple amendments can make them even more so. Add foreign-language leases that reflect the nuances of local markets, and it becomes clear that it can take considerable thought to interpret the data required for reporting.

4. Expect to source data from multiple places.

A lease agreement does not spell out everything that’s needed for ASC 842 accounting and disclosure mandates. For example, determining the appropriate discount rate and fair market value of a leased asset often requires management judgment and — in some cases — the use of quantitative modeling. In addition, there are other data requirements that may not be derived directly from the lease agreement, in which case an alternative data sourcing approach may be required.

5. Controls and processes may need an upgrade.

Legacy U.S. GAAP might have left room for decentralized lease processes, but that’s often less practical and efficient under ASC 842. Beyond the required internal controls and processes that companies need to produce financial statements in a clear and efficient manner, there’s also impairment accounting, modification accounting, and reconciliation between actual and contractual cash flows. Existing business processes and controls need a refresh and the new concepts likely will drive development of revised processes and controls.

6. Technology helps — but needs plenty of runway.

ASC 842 rules require significantly more data and calculations to produce the appropriate journal entries and disclosures. The upshot is that manual processes are less practical — not just for lease data maintenance, but for compliance and management reporting as well. That said, it’s worth taking the time to confirm that a technology solution has the applicable functionality and to gain an understanding of how long it is likely to take to get it up and running — it may take longer than anticipated.

7. An incremental borrowing rate is full of moving parts.

Generally, ASC 842 requires lessees to record each lease on the balance sheet using a collateralized incremental borrowing rate (IBR). But having existing debt may not be enough to determine the IBR; it depends on the nature of the company’s debt, lease term, and lease currency. The nuances of establishing rates — think identification of the appropriate entity-specific credit risk adjustment or the impact of full collateralization — is what makes IBR far more complicated than what many companies expect.

8. Other departments will likely need to get involved.

ASC 842 implementation isn’t just an accounting endeavor, as many companies have found. Procurement, for instance, may be needed to help pull together the full population of leases. The tax department may need to determine deferred tax assets and liabilities. If a lease accounting software solution includes lifecycle management functionality, real estate personnel should review it to determine if it’s useful from their perspective, and — of course — IT should approve and support the technology implementation. Business units should also be involved since they may need to monitor and maintain the leases to which they’re closer to.

9. Affected groups can all benefit from ASC 842 adoption.

Companies can’t avoid the new standard, so they should make the most of it. A carefully thought-out ASC 842 implementation can yield enhanced analytics, modeling and forecasting capabilities. At the same time, new lease accounting processes can jumpstart related initiatives such as procurement or real estate management and optimization, contract management, and compliance and contract digitization. The result? Potentially more effective decision-making and improved performance across the portfolio of leased assets.
The new standard dramatically increases the number of leases that companies may need to record on their balance sheets. The good news is that many of the key stumbling blocks of ASC 842 implementation are now known — and each one of them is manageable. With appropriate planning, private companies can equip themselves to achieve a smooth transition to this landmark update in lease accounting.