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FASB

Private Companies Misjudging Level of Effort Needed to Adopt New lease Accounting Rules

Denise Lugo  Editor, Accounting and Compliance Alert

Denise Lugo  Editor, Accounting and Compliance Alert

Some private companies have misjudged the amount of backwork the FASB’s lease accounting standard requires and could run into adoption issues this year, accounting practitioners said.

Private manufacturing and real estate companies that do not already have a central repository of leases defining their true lease inventory, still have not begun the heavy lifting needed to adopt the rules, which take effect this year.

“What we have seen is a lot of companies don’t truly understand the complexity and the level of involvement required for a successful adoption,” Jon Eilertsen, BDO, Accounting and Reporting Advisory Services partner, said on February 14, 2022.

“Recently, we’ve seen a lot of decentralized companies who have a variety of lease types – whether it’s real estate leases, vehicles, copiers, printers, where they have complex leases that require a significant level of attention,” he said But “with the pandemic and all of the resulting changes in priorities and internal staffing bandwidth that have taken place, companies and their management teams have delayed their adoption steps.”

A critical component of the standard addresses embedded leases that companies might not be aware that they carry, that under prior rules might not have mattered as much, Eilertsen said.

“For example, if you’re a manufacturing company and maybe you contract out third parties to help to manufacture parts that you’re using that’s key in your process to putting together your products you’re selling – if you’re obtaining substantially all of the economic benefit of the equipment that these suppliers are using in order to fulfill your orders to manufacture those parts, that equipment could be deemed as a lease on your books,” he said. “And so understanding the details of service arrangements – or service contracts that company’s likely treated as expenses historically, now comes with an added level of scrutiny and could be determined under the new rules to be an embedded lease, which could have a significant impacts on companies, not only creating potentially new operating and finance leases, but could also impact debt agreements with their lenders upon their 842 adoption.”

The guidance, Topic 842, Leases, was issued in 2016 to require the full magnitude of long-term lease obligations to be reported on companies’ balance sheets, a first in U.S. history. The rules took effect in 2019 for public companies; it takes effect this year for private companies after being deferred twice.

It’s Hard Work

“The adoption of this standard is not easy,” Richard Stuart, RSM, National Accounting Standards partner, said on February 14. “Some of the shortcomings we’re seeing is some entities are just keeping the adoption efforts within the accounting group and that’s not necessarily good because the controller’s group is not always going to know all of the leases and leased assets,” he said. “Or they’re coming out and they’re saying ‘this isn’t going to be hard at all’ – it’s going to be hard.”

Outside of the practical expedients and options under the rules, companies have to dig into the leases and extract the data they are going to need which is critical, Stuart explained. Companies need, for example, to determine whether there are variable payments in the lease, whether there is a floor or ceiling on those variable payments, whether there are purchase options, renewal option, termination options which can factor into the accounting.

“You’ve got to have somebody go through and analyze those leases – those leases might have been out there for five, ten, fifteen years by now and have been modified multiple times, and now you have to go through and make sure you’ve got the accurate version of the existing lease,” he said.

Companies need to determine which expedients and options are best as there are number of options to the rules, including: the option to combine lease components and non-lease components; determining the rate used when discounting liabilities; and on how to transition to the rules. The big issue, however, is probably the so called package of practical expedients and it is going to take time to determine the ins and outs, practitioners said.

“And it’s three expedients that if adopted you have to adopt all three,” said Stuart.

“For example, if you don’t apply the package, you’re going to have to go back and revisit your prior determination of whether the contract is a lease or contains a lease. It makes it much easier if you adopt the package but some entities just don’t want to do it – and some entities didn’t go through that initial analysis under the old rule of whether or not a contract contained a lease because it wasn’t really a big impact under the old rules because virtually everything was straight line,” he said. “If you adopt the package, you are required to apply all three, so you don’t worry about the impact one might have on the other.”

For in-depth analysis of the FASB’s standard for lease accounting, please see Catalyst: US GAAP — Leases, also on Checkpoint.

 

This article originally appeared in the February 15, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.

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