The New Normal for Lease Accounting

On the heels of the recent standard for revenue recognition, it’s time to shift focus to leases. Public companies just finished dealing with revenue recognition and now must pivot quickly to address leases. Private companies get to learn from their public friends and adopt each a year later but should be laying the groundwork now to avoid a scramble down the road. If you are a lessor, the impact is not significant. However, just about all companies and organizations are lessees in some form and must pay close attention to how the standard changes things going forward.

What’s the big deal? In a continued effort to converge International and US guidance, the standard setters gave us ASC 842, Leases. While there are a number of nuances to consider, the bottom line is that most of what we call operating leases under the existing standards will now be recorded on the balance sheet.  

You will now see Right-of-Use Assets and Lease Liabilities recorded for many leases that were formerly expensed over time.While it sounds simple enough, of course, the devil is in the details. Not only does your accounting group need to evaluate all traditional leases, but must also evaluate leases lurking in the shadows of agreements.  

Certain terms in agreements may now be considered “embedded” leases and will require evaluation. All of this can be overwhelming, but the process can be summarized in the following LEASE steps:

‍L – Leases – All leases should be aggregated for evaluation. Particularly, those with terms exceeding 12 months will require analysis to determine whether they represent at Right-of-Use asset to be recorded on the balance sheet. Not only is it important to capture the lease population, but an understanding and summarization of key terms is critical.

‍E – Embedded Leases – These are the pesky agreements that meet the new lease definition, but are sometimes hard to spot. Perhaps you outsource the manufacturing of your products or utilize service agreements for some of your processes? These are just some examples of the types of contracts that may contain an embedded lease. Careful analysis is required to find embedded leases, so beware.

‍A – Assess – Once all the pieces are on the table, you can begin to solve the puzzle by applying the guidance to each agreement. While there may be many similarities across the population, slight differences and unique characteristics require a careful eye to see and analyze.  

You’ll not only need to address the accounting impact, but also the internal control and IT changes needed.  Systems and processes designed for the old standard will likely prove inadequate for the new standard.

‍S – Summarize – After analyzing the population, it’s time to put together the documentation of approach, impact, and ongoing monitoring processes. Getting to the initial adoption impact and journal entry is only the first step, as the revised and expanded disclosures may require more effort than previously thought.

‍E – Educate –  This standard impacts more than just the accounting and finance departments. All of your team members should understand this standard and how it can change the nature of transactions. Key steps in this ongoing phase are developing policies, templates, and monitoring processes.

On the surface, this looks relatively straightforward. However, this standard may prove more difficult than first believed, as the process can take much longer than anticipated. As adoption nears and the landscape shifts, having a trusted and experienced expert at your side can prove invaluable.

For questions, contact us.