For many businesses and their accounting departments, the recent move to the new ASC 606 revenue recognition rules from the Federal Accounting Standards Board (FASB) was eye opening. The process of implementing these changes regarding when and how to report customer payments on income statements proved to be more difficult than a lot of people anticipated.
And now, for private companies, the deadline for compliance with the new FASB lease accounting standard, ASC 842, is right around the corner.
What lessons can these companies learn from the transition to ASC 606 and apply to ASC 842? We’ve put together 8 key tips that are applicable as you work on achieving ASC 842 compliance.
1. There’s no time to waste.
When the deadline for private companies to implement ASC 842 was extended to January 2021, some companies put the task on the back burner so they could concentrate on adoption of ASC 606.
But consider this: While ASC 606 was issued in May 2014, the rules did not go into effect until fiscal year 2018 for public companies and a year after that for private companies. That gave companies years to prepare — yet, many still found themselves scrambling to meet the implementation deadlines.
The message for companies still getting ready for ASC 842 compliance is clear: It is critically important not to underestimate the time and effort that will be required to meet the new lease accounting deadline.
Depending on the size of your business, simply finding the most current version of all leases can be a daunting task — and that’s before lease analysis, data input, and any software implementations get underway.
So, if you have not already begun the ASC 842 compliance process, we can’t say it enough: You need to start right now.
2. Lease contracts are complex, so you’ll need more time than you think.
For many companies, the move to the ASC 606 took more time than expected due to the intrinsic complexity of contracts. With differences in compensation plans, commissions, terms, and other details, no two contracts are exactly alike — which means it takes time to read through and identify all the pertinent details.
The same is true of the lease contracts included under ASC 842. People often underestimate the task of accounting for all their leases, including facilities, IT and office equipment, vehicles, and other assets.
For example, although almost all leases must be capitalized on the balance sheet under ASC 842, you still need to classify them as either finance leases or operating leases, because they are calculated differently.
In addition, once you start breaking down the details of a lease, you may be surprised at the level of complexity that is revealed. For instance, real estate leases often include common area maintenance (CAM) charges and additional items that must also be calculated and reported.
Therefore, go into the process knowing that some leases you thought would be easy to analyze might end up taking more steps or revealing unexpected details that will affect your accounting decisions.
3. Cast a wide net and enlist other departments to identify leases.
Under ASC 606, organizations quickly discovered that a team approach was necessary to account for all contracts pertaining to customer revenue.
With the vast amounts of data pertaining to leases across a business, the ASC 842 accounting team cannot go it alone either. It’s crucial to talk to many other departments within the company to track down all the possible sources of leases.
Working with a team made up of all the key stakeholders from areas including Facilities, Real Estate, Legal, IT, and Procurement staff, as well as Accounting experts, will help you:
- Locate all the leases that the business holds
- Make sure you have the most up-to-date and accurate records
- Understand all elements of the contracts so that the standards can be applied correctly and consistently
- Determine whether it is likely that renewal or purchasing options will be exercised
- Find important related documentation, such as contract addendums, commencement letters, and interest rates
4. Examine all contracts for embedded leases.
With revenue streams often coming from many different sources and contract terms varying so greatly, ASC 606 adopters often found crucial details in surprising places.
To avoid surprises in ASC 842 adoption, be sure your lease analysis includes reviewing all your contracts thoroughly to identify embedded leases — components within a contract that provide for the use of a particular asset.
For example, the portion of a service contract specifying the use of on-site equipment provided by the service vendor might be considered a lease, even if the word lease is not used.
5. Create a process for collecting lease data.
The need to review every contract for ASC 606 compliance made it clear that creating a data collection process in place helps to ensure all team members understand the task at hand.
With an ASC 842 team including stakeholders from different areas of the business, not everyone will be an accountant or a lease expert or both. Providing a process for lease data collection and making sure all team members understand what they need to do will ultimately help to ensure the accuracy of your financial reporting.
For example, you can create a process that includes guidelines such as:
- The types of data points you need for calculations
- Suggestions of where to find lease data in complex contracts
- Any supporting documents you may need
- The types of payments that need to be broken out, like base rent, CAM, taxes, and insurance
6. Evaluate early to assess long-term potential impact.
Another important reason to start analyzing your leases as soon as possible is that decisions you make now will affect your lease accounting practices for the long term.
This does not just include deciding how all your leases should be classified and, accordingly, how they will be recorded on the balance sheet. It also includes decisions such as which ASC 842 practical expedients you will utilize and the impact they will have on your financial reporting.
Making these strategic decisions before you collect your lease data will save you from discovering later that you need to backtrack and search for additional information to complete your lease calculations.
7. Implement new policies for leases moving forward.
While evaluating their contracts for ASC 606, many organizations found ways to change the way they were doing things and improve how contracts are written moving forward.
The same can be true of ASC 842 and lease accounting. By putting these standards in place, you have opportunities to make accounting decisions and create new practices that can help to ensure the best financial outcome for your company.
This process can serve as a learning experience that can help you bring greater standardization to new contracts, avoid complexity wherever possible, and make lease accounting more efficient. In addition, a review of all your current leases can uncover opportunities to consolidate expenses, exercise purchasing options, or renegotiate prices to save the business money.
8. Get the help and tools you need.
As with ASC 606, many companies will need assistance making the transition to ASC 842. This is especially true with the deadline fast approaching and the time to train an internal team slipping away.
Perhaps you are short of staff who know how to interpret and extract data from complex lease documents. Maybe you are unsure how to weigh the time savings of practical expedients against their impact on your balance sheet.
An accounting advisor can help to guide you through the ASC 842 transition requirements and all the important decisions you need to make. In addition, you can take advantage of abstraction services, project management, and other third-party support for ASC 842 compliance.
Most companies will also benefit from lease accounting software that serves as a central repository for lease data and performs lease accounting calculations. Or, you can opt for a lease management system — an all-in-one solution that provides full lease accounting plus lease administration capabilities for ongoing management of your lease portfolio.
To learn more, download the guide Lease Accounting and Lease Administration Software: Why You Need Both.