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FASB

Top 5 Issues to Master to Adopt FASB Lease Accounting Rules This Year

Denise Lugo  Editor, Accounting and Compliance Alert

Denise Lugo  Editor, Accounting and Compliance Alert

Private companies, the largest business demographic in the U.S., have to adopt the FASB’s new lease accounting standard starting this month, but many are still lagging in those efforts.

Early adopters caution that the rules can bulk up balance sheet liabilities which could have debt covenant implications.

“We have a huge increase in finance leases as a result of 842,” said Douglas Uhl, principal team leader, corporate accounting policy at Chick-fil-A, Inc., during the FASB’s advisory meeting in December. “That was something we had to work with our debt holders internally – now we’re going to have all these debt-like liabilities on our balance sheet,” he said. “Nothing has changed economically with our leases, it’s simply a nuance of the classification guidance that changed.”

Topic 842, Leases, also referenced as Accounting Standards Update (ASU) No. 2016-02Leases, requires companies to report the full magnitude of their long-term lease obligations on the balance sheet – a historic first in the U.S. The rules took effect in 2019 for public companies, but were deferred twice for private companies and will take effect after December 15, 2021, i.e. January 1, 2022 for calendar year-end filers. Earlier adoption is permitted.

Companies generally use accounting software vendors when applying new standards, but should not wait too late to get on their radar, FASB discussions indicated.

Some CFOs are having problems accessing software vendors, Holly Nelson, chief executive officer at Key Advisory Services, said. “Everybody put it off until the last minute, and were having trouble implementing because they need the software vendor to do things and they’re stacked up with all of the different companies,” she said.

Lease accounting software vendors said surveys they have taken show most private companies have not yet adopted the rules. They flagged the following as the top five issues to pay attention to:

  • Developing a Process to Create the Inventory of Leases. Putting together a cross departmental team from divisions such as real estate, procurement, legal, IT in order to identify all leases. “One of the biggest challenges that companies face with the new lease accounting standard is just identifying where all their leases are,” Joe Fitzgerald, Senior Vice President of Lease Market Strategy at Visual Lease, said on December 28, 2021. “What we find with companies is that their real estate leases tend to be somewhat centralized in the organization – that they kind of have a handle on where they are and who they’re with – while non-real estate leases – vehicles, IT equipment, etc. – tend to be very decentralized and not always readily available,” he said. “So, you really will need to get a complete population of your leases together, which is one of the first steps and it will be one of the things I can guarantee that your auditors are going to kick the tires on and test you on when they come in to do their audit at the end of the year.”
  • Accounting Policies on Adoption. The standard includes three practical expedients that have to be selected as a package, but there are other policies that a company needs to go through and select when determining materiality thresholds. For private companies especially important is determining how they are selecting a discount rate – whether using an incremental borrowing rate, or a risk free rate. The FASB recently provided accommodations for private companies that allow them to select a risk free rate by class of assets. “I think it’s going to be important for private companies to think through all of these elections,” Jennifer Booth, accounting vice president of Georgia-based LeaseQuery, said on December 27. “Start documenting those and along with that the impact on your financial statement that this whole lease process has,” she said. If in this process the company identifies that it did not have some of its leases accounted for, it has to go back and consider the implications under Topic 840, Leases, and then start accounting for them under Topic 842. “You can’t just say ‘oops I didn’t do it historically, I’ll forget about those,’” Booth said.
  • Company Expertise on ASC 842. Public companies that adopted the rules had staff that sufficiently understood Topic 842 and could manage the whole project, which requires a team effort, the vendors said. Others outsourced the work. Private companies that do not have personnel that are versed on Topic 842 would likely need to hire a consultant to join their team. A major part of the work is extracting data such as a lease commencement date, lease payments, term options, and the discount rate.
  • Software. Software should not only handle the initial adoption but also go-forward entries on a monthly basis and required disclosures. “A good software will allow you to say ‘I have a modification, these are my changes’ and it will process the accounting for you,” said Booth. “What we’ve seen some public companies get pigeon holed on is they set up their software to be the old process, the way they used to do it, instead of ‘how can the software function into the company’s new control environment and new controls and new processes,’” she said.
  • The Day Two Implications. Leases are very dynamic so while there is an initial asset and liability that needs to be booked on the balance sheet it is not a “set it and forget it” because leases are going to change literally day two. “This is not a one and done, said Fitzgerald. “So if you book it at effective January 1, as early as the next day a company may have new leases are coming on, old leases going off, there’re amendments to the leases, particularly in the real estate arena – very dynamic,” he said. “So those changes and those modifications could result in what we call in accounting ‘subsequent measurement’.”

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

Additional analysis of the lease standard can be found in the Accounting and Auditing Update Service[AAUS] No. 2016-15 and SEC Accounting and Reporting Update Service[SARU] No. 2016-13 (March 2016): Special Report: Accounting for Leases—an Explanation and Analysis of Accounting Standards Update No. 2016-02.

 

This article originally appeared in the January 3, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.

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