ASC 842 Implementation for Private Companies: Lessons Learned from Public Companies

According to a recent poll of 350 finance and accounting executives, 40 percent of private companies are running behind schedule or haven’t even started planning for the transition to ASC 842, which goes into effect for those entities with fiscal years beginning after December 15, 2019. Most public companies have already been required to implement the new standard, offering their private company counterparts lessons on challenges encountered and solutions deployed—making this a good time to take stock of where your company is on the ASC 842 implementation timeline.

The New Lease Accounting Standard: An Overview

Accounting Standards Codification (ASC) Topic 842, also known as Accounting Standards Update 2016-02, requires organizations to include lease assets and liabilities on their balance sheets. Published by the Financial Accounting Standards Board (FASB) in 2016, the new standard closes a major accounting loophole in the previous standard, ASC 840.
 
The off-balance sheet operating lease loophole allowed companies to omit certain lease assets and liabilities from their balance sheets, potentially skewing their debt-to-equity ratio. In 2016, the International Accounting Standards Board estimated that public companies using either the IFRS Standards or U.S. GAAP had around $3.3 trillion of lease commitments, 85 percent of which were not recorded on their balance sheets. This, of course, makes it difficult for shareholders, investors and lenders to get a true sense of a company’s financial health. For example, when electronics retailer Circuit City closed its doors in 2009, its balance sheet reflected debt of $50 million. But the company also had off-balance sheet leasing liabilities of $3.3 billion, 65 times the reported amount.
 
Under ASC 840, operating leases were only required to be disclosed in the footnotes of corporate financial statements. Under ASC 842, the only leases that may be omitted from financial statements are short-term leases with an original term of less than 12 months. By closing the loophole, ASC 842 increases transparency and comparability among organizations that enter into lease agreements and provides a clearer picture of an organization’s leasing obligations.

Lessons Learned from the Public Company Experience

Despite the FASB issuing simplifications to the process at the end of 2017, implementing ASC 842 posed a challenge for many public companies. The standard requires the collection of as many as 100 fields of data from every lease that exists on, or will exist after, the effective date. Analyzing leases to identify and extract those details for inclusion in the organization’s balance sheet requires substantial time and resources. In fact, a recent Bloomberg Tax survey of 500 professionals responsible for tracking, accounting, or expensing leased assets for their organizations found that over 80 percent have leases that need to be accounted for under ASC 842, most of which are material to financial reporting.
 
This is especially true when it comes to embedded leases. As the name implies, embedded leases are a component of larger business agreements, such as service, outsourcing or maintenance contracts. They may also be found within warehousing, security, transportation or data storage contracts, making them harder to identify than agreements specific to assets such as real estate or equipment. Because embedded leases exist across departments outside of accounting, coordinating to identify these leases and procure the required information makes the task particularly time-consuming and complicated.

Best Practices for Implementation

While the transition to ASC 842 puts heavy demands on organizations, there are proven approaches to easing the burden and streamlining the process:

Solicit the involvement of the entire firm

Although the implementation of ASC 842 is primarily the responsibility of the organization’s accounting department, successful implementation requires support from across the firm, especially when an organization has a large real estate portfolio or embedded leases. Companies with a disaggregated operating structure, whereby multiple parties within an organization may have the ability to enter into a leasing arrangement, will need to work especially closely with their colleagues across the business. This may mean seeking assistance from IT, legal, or procurement departments. Soliciting executive sponsorship to champion implementation will also help to streamline the process.

Use technology to your advantage

Under the stress of deadlines, the organization of lease terms and data can be daunting, especially within larger companies where leases may exist across departments. For organizations that have developed a robust data governance program, or specific procedures to collect and manage enterprise data, implementation should be considerably easier. However, for the many organizations that have yet to build out these structures, there are off-the-shelf and purpose-built technology solutions that can help standardize and aggregate the information. For example, key lease terms and agreements can be stored in a central database, granting relevant team members the ability to streamline access to, and organization of, relevant leasing information. Advanced leased asset systems with web services and rules engines can be used to export, transform, and load data.

Keep an open line of communication

For public companies, ASC 842 has posed a challenge for investor relations teams communicating earnings and other guidance to the investing community. With operating leases now required to be disclosed on the balance sheet, companies may appear more highly leveraged, though their recognized expenses in income statements should not be affected. According to the Wall Street Journal, corporate balance sheets have the potential to grow by as much as $2 trillion under ASC 842.
 
While their reporting requirements are different, public companies’ experiences communicating financial health to investors based on these new regulations should have private companies thinking about their own communication to stakeholders. The key is transparency. With such large adjustments being made to an organization’s financial statements–particularly the balance sheet–it is vital that leadership be able to keep stakeholders, especially those with a financial interest in the company, well-informed throughout the transition.

The time to get started is now

From identifying to reclassifying lease commitments, it’s clear that complying with the ASC 842 standard is a time-consuming process. Private companies with a calendar year-end will need to implement the new standard by January 1, 2020. These entities should develop an implementation timeline with a number of factors top of mind, including existing lease commitments, data governance maturity and cross-firm coordination needs.
 
Retailers, drug stores, restaurants, supermarkets, airlines and telecommunications companies in particular have seen an outsized impact on their balance sheets because of large brick-and-mortar footprints. Those industries should factor in extra time for both implementation and keeping stakeholders informed. Unexpected roadblocks such as a delay in receiving necessary data from external sources should also be accounted for in the timeline.
 
Benchmarking the organization’s progress on implementation against its timeline throughout the balance of the year is paramount in keeping on task and meeting goals.
 
Are you ready to get started? BDO’s Accounting & Reporting Advisory Services professionals can provide initial consultation on your current state of readiness to kickstart the process.

 

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