Learning from Public Companies: ASC 842 Insights for Private Businesses

by / ⠀Featured News / July 26, 2023
Learning from Public Companies: ASC 842 Insights for Private Businesses

The implementation of Accounting Standards Codification (ASC) Topic 842, also known as ASC 842, has heralded profound transformations in lease accounting for U.S. public companies. By the end of 2019, lease liabilities totaling up to $3 trillion will have been imprinted on the balance sheets of these entities Introducing a new lease accounting standard, the Financial Accounting Standards Board (FASB) crafted ASC 842 with the intention to bestow investors with an enhanced comprehension of companies’ lease obligations, encompassing those for both equipment and real estate

Whilst public companies have been meticulously navigating the labyrinth of challenges imposed by ASC 842, private companies too are diligently preparing for its impending implementation. Drawing invaluable lessons from the experiences of their public counterparts, private enterprises aim to ensure a seamless transition to the novel lease accounting standard. In this article, we shall delve into the key insights gleaned from the implementation of ASC 842 by public companies and explore how they can be judiciously applied to the realm of private businesses.

1. Some Leases are not Clearly Labeled “Lease”

One of the paramount lessons drawn from the ASC 842 implementation is the revelation that not every lease is explicitly denoted as such within contractual agreements. Embedded leases lie concealed within a myriad of agreement types, ranging from transportation service agreements to information technology (IT) service contracts and electronic contract manufacturing arrangements Despite these agreements functioning as components of more extensive contracts for products or services, private enterprises must be vigilant in acknowledging that if such agreements confer the right to govern the use of a specific asset for a predefined duration in exchange for remuneration, they may very well qualify as leases.

2. Leases Can be Found Across the Organization

Amidst their journey towards ASC 842 compliance, public companies have stumbled upon leases strewn across a plethora of departments, business units, and office premises Ensnared in a labyrinthine of administrative systems, intranet sites, or desktop spreadsheets, tracking these leases proved arduous. In some cases, leases were preserved as images, searchable PDF files, or tangible hard copies, demanding painstaking efforts to uncover the complete repository of leases. To ensure adherence to ASC 842, private companies must brace themselves to embark on an exhaustive quest to unveil leases ensconced within their organizational domains.

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3. Lease Data Requires Considerable Judgment

Under ASC 842, companies bear the responsibility of meticulously monitoring critical dates, payment amounts, and other salient information pertaining to the right of use conveyed by lease contracts These provisions often entail complexities, further compounded by any subsequent amendments to the lease agreements, thus rendering the interpretation of data for reporting a formidable task. Moreover, dealing with leases expressed in foreign languages may introduce further intricacies, necessitating meticulous contemplation and elucidation. In handling lease data, private companies must anticipate the necessity for comprehensive analysis and the application of discerning judgment.

4. Expect to Source Data from Multiple Places

While lease agreements serve as a prime source of information, they may occasionally lack certain details imperative for ASC 842’s accounting and disclosure prerequisites. In such instances, management discretion, and at times, quantitative modeling, become indispensable in determining an acceptable discount rate and the fair market value of a leased asset. Complying with ASC 842 standards necessitates private entities to be equipped to gather data from an array of sources and employ diverse data-gathering strategies.

5. Controls and Processes May Need an Upgrade

Under legacy U.S. Generally Accepted Accounting Principles (GAAP), decentralized lease processes were the norm. However, the advent of ASC 842 calls for a more centralized and efficient approach Embracing this new standard requires companies to instate robust internal controls and processes, encompassing financial statement production, impairment accounting, modification accounting, and reconciling actual and contractual cash flows. This juncture presents private companies with an opportunity to introspect and enhance their lease-related controls and processes.

6. Technology Helps but May Require Sufficient Implementation Time

With ASC 842 ushering in a wealth of data and calculations indispensable for generating the requisite journal entries and disclosures 1, the viability of manual processes may diminish for lease data maintenance, compliance, and management reporting. Private companies exploring technological solutions must ensure that they possess the requisite functionality to meet ASC 842 requirements. Additionally, a prudent evaluation of the implementation timeline becomes essential, as integrating the technology solution may prove more time-consuming than anticipated.

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7. An Incremental Borrowing Rate Involves Multiple Factors

Leases must be recorded on the balance sheets of public company lessees in accordance with ASC 842, with 1 being the collateralized incremental borrowing rate (IBR). Complex elements, including entity-specific credit risk adjustment, full collateralization, and leasing currency concerns, go into calculating the IBR. However, private enterprises can still choose to use a risk-free rate rather than an IBR For privately held businesses, the importance of calculating the IBR cannot be overstated because of the potential impact on lease obligations.

8. Involvement of Various Departments

Embarking on the implementation of ASC 842 does not pertain solely to the realm of accounting. Various other departments, including procurement, tax, real estate, and IT, may need to partake in the process Procurement’s assistance proves invaluable in identifying the full spectrum of leases, while the tax department’s purview extends to evaluating deferred tax assets and liabilities. Concurrently, real estate personnel must diligently review lease accounting software functionality, with IT actively supporting and approving the implementation of technology solutions. Collabo

ration among these diverse departments ensures a comprehensive and successful implementation of ASC 842.

9. Benefits of ASC 842 Adoption

While ASC 842 compliance may appear daunting, private companies can seize this transition as an opportunity to reap valuable benefits. A well-thought-out implementation can modeling, amplify analytics, and forecasting capabilities Moreover, the revamped lease accounting processes can serve as catalysts for optimizing procurement, real estate management and optimization, contract management, as well as compliance and contract digitization. Consequently, private companies stand to enhance decision-making and overall performance across their portfolio of leased assets.

Conclusion

The implementation of ASC 842 presents both challenges and opportunities for private companies. By gleaning wisdom from the experiences of public companies, private businesses can navigate the complexities of ASC 842 more adeptly. Understanding the intricacies of lease accounting, engaging various departments, upgrading controls and processes, and harnessing technology will contribute to a successful transition. Private companies should embrace ASC 842 as an opportunity to elevate their lease management practices and improve overall financial reporting.

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FAQ

What is ASC 842?

ASC 842 is the new lease accounting standard introduced by the Financial Accounting Standards Board (FASB) to provide investors with a clearer understanding of companies’ lease obligations.

How does ASC 842 impact private companies?

ASC 842 mandates private companies to record lease liabilities on their balance sheets, mirroring the requirements for public companies.

Are all leases explicitly labeled as leases?

No, leases can be embedded within various types of contracts and may not always be clearly labeled or defined as leases.

What are the key challenges of ASC 842 implementation?

ASC 842 implementation involves identifying leases across the organization, interpreting complex lease data, sourcing data from multiple places, upgrading controls and processes, and potentially adopting new technology solutions.

What are the benefits of ASC 842 adoption?

ASC 842 compliance can lead to enhanced analytics, modeling, and forecasting capabilities. It can also serve as a catalyst for optimizing procurement, real estate management, contract management, and compliance and digitization efforts.

Can private companies use a risk-free rate instead of an incremental borrowing rate (IBR)?

Yes, private companies have the option to use a risk-free rate instead of an IBR, but this may result in higher lease liabilities.

Which departments should be involved in ASC 842 implementation?

Departments such as accounting, procurement, tax, real estate, and IT should collaborate to ensure a comprehensive and successful implementation of ASC 842.

How can private companies prepare for ASC 842 implementation?

Private companies should conduct a thorough search for leases within their organizations, upgrade controls and processes, evaluate technology solutions, and seek expert guidance to ensure compliance with ASC 842.

 

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