We are now in the final stretch for private companies to meet the deadline for the implementation of the new accounting standard, ASC 842. Issued by the Financial Accounting Standards Board (FASB) in 2016, ASC 842 goes into effect in January 2021 for private companies, and requires businesses to record lease obligations that are longer than one year on the balance sheet as a liability and asset. Prior to the change, these obligations were only recorded on the income statement.
Having spent the past few years working with public companies that needed to adopt the new standard by the first quarter of 2019, we know how challenging this process can be. Fortunately for private companies, we are leveraging this experience to guide and share the insights we have learned.
Here are seven tips for private companies who need to work to implement this new standard.
1. Benefits Gained Will Go Beyond the Balance Sheet
While the changes that will need to be implemented are being brought on by the need to meet the new lease accounting standard, companies should realize that they will gain much more with the proper implementation. With the systems and procedures that will need to be established, business leaders will see improved lease management processes, greater visibility to leasing costs, and ultimately, the ability to make better leasing decisions that can result in cost savings.
2. Start Early
If you haven’t already established your team and have a plan in place, you are behind the eight ball. Depending on the size of your lease portfolio, this process can take anywhere from six months to well over a year. There is no harm in getting your systems established early to allow a cushion for testing and adjustments, so, avoid working with a tight schedule.
3. Assemble Your Team
A successful adoption will not be achieved by only one or two people. One common mistake we have seen many companies make in the past is to rely solely on their accounting team. While the end result is an impact on the balance sheet, representation from procurement, real estate and a solid third-party consultant that understands the standard is extremely critical.
4. Utilize the Correct Software & Understand the Data
The calculations required for the new accounting standard are complicated and will not be sustainable in Excel if you have multiple leases. While private companies won’t be subject to strict SEC reporting guidelines and might be tempted to take shortcuts, it is critical to produce accurate information to maintain the confidence of investors and lenders. So, while one-location companies can probably get by with spreadsheets, if you have to track a portfolio of contracts, new software will need to come into play. With that said, do not expect the software alone to be the solution. We have seen a number of companies make the investment in a good software product, only to populate it with inaccurate data and assumptions. As mentioned above, a team that understand all data points is key.
5. Data Collection & Identifying Leases Takes Effort
It sounds easy, but the gathering of lease contracts may prove to be more challenging than anticipated. From missing documents, to decentralized storage, to embedded or implied leases in service contracts, companies are underestimating the time and effort needed to gather and abstract these documents. Most companies also default to contracts with the word “lease” in the title, such as real estate or equipment leases. However, there are many other contracts that may include what is known as an “embedded” lease under the new standard. Examples include service contracts where a company has use of an asset. This is why procurement is a critical part of the team. All existing and future contracts need to be reviewed and evaluated to ensure the population is complete.
6. Know the Code
This sounds obvious, but there are many data points and decisions that go into the calculations for ASC 842. We are regularly being brought in during the adoption process and finding improper inputs and assumptions being made. The end result is unnecessary liabilities being reported on the balance sheet.
7. Maintenance is Critical
With the number of leases likely to be identified during this process, the ability to maintain the data on an ongoing basis is key. This means staying on top of any modifications, additions or expirations of contracts.
The entire implementation is a time-consuming group effort and can be overwhelming if not faced with proper plan and resources. At Hughes Marino, our portfolio lease administration and advisory team is assisting in the process with clients and has systems in place to help companies get on track and wrap their arms around what will be a significant addition to their balance sheet. Proactive companies are embracing this reality and finding a lease administration partner, and we would love the opportunity to become an extension of your own team and assist you with the challenges ahead.