American enterprise is about to get hit with $3 trillion in new liability. When the new lease accounting standards known as FASB ASC 842 take effect at the end of 2021, every company with leased property must take a drastically new approach to their balance sheet. Now’s the time to get prepared.
ASC 842 replaced ASC 840 to eliminate a loophole that allowed companies to show cleaner balance sheets than might be true by omitting certain leasing obligations. The rules were born after the Enron fallout, and ASC 842 is the latest revision.
As with the previous rules, ASC 842 classifies leases as either operating or finance leases. Unlike the previous rules, however, you must now record both types of leases on the balance sheet. Accountants have the option not to record leases that last less than 12 months. They must also apply a different expense recognition pattern for each kind of lease classification—among many other new rules included in ASC 842.
Accounting standards change often, but rarely on this scale, with this level of complexity, or with such high consequences. The FASB has already pushed back the deadline for ASC 842 implementation to give companies more time to prepare. For some, though, it might not be enough.
Obstacles to Compliance
Complying with ASC 842 will be challenging for all companies for three reasons that build off each other. First, even just a few corporate leases represent a large and complex portfolio of information. Keeping it organized, integrated and accessible to the extent that ASC 842 compliance requires won’t be easy, especially for companies with larger portfolios of properties.
Second, the real estate and finance teams have traditionally worked separately. But now that all leases must appear on the balance sheet subject to complex rules, the two departments must be linked like never before. That link won’t be built overnight. More problematically, giving both sides access to the same extensive leasing information will require a major effort to integrate and distribute the data.
No one anticipated the third reason: Covid-19. Within a matter of months, the pandemic transformed how companies think about commercial lease management and threw many lease agreements into turmoil. These sudden and sweeping changes only make the previous two issues harder while raising questions about how to account for lease contract changes that even regulators hadn’t considered before.
With only months until the lease accounting standard update goes into effect, there are still plenty of hurdles to clear. Companies will need to plan their time and resources carefully to get compliant in time.
Planning for FASB ASC 842
Create the most effective implementation plan possible by taking these steps.
- Start immediately: Compliance will likely take twice as long as you expect. Consider what’s involved: First, creating a comprehensive database of all leasing information that’s accessible throughout the company. This may include rereading contracts, especially service contracts, to determine whether a contract is or contains a lease to ensure your company has a complete population of leases. Then, you must build processes to incorporate changes resulting from adopting and maintaining compliance with ASC 842. It’s a major undertaking that touches on people, processes and technology, so it’s important to get started immediately.
- Get up to speed: ASC 842 will affect every lease portfolio differently. You will need to understand both what that portfolio includes, in granular detail, and how the new rules apply, with the same granularity. Early in the implementation plan, take a deep dive into the new rules with members of the accounting, finance, internal audit, legal and real estate teams. At the same time, start collecting all leasing information in one place to facilitate the transition.
- Create a committee: Putting all the necessary parts in place by the end of 2021 will require a dedicated ASC 842 team to drive the effort forward. Include members of the real estate, legal, IT and finance teams—they will all have important perspectives and, in some way, will be affected by the new lease accounting standards.
- Look inward: Determine what resources you need to complete the workload associated with ASC 842, then evaluate whether your company has those resources. Hiring is one way to make up the difference, but skilled accountants are in short supply. Technology and outsourcing are alternatives that both merit consideration, especially if they can make compliance possible in the short time left.
FASB ASC 842 compliance might be a burden, but it has a silver lining: Once all leasing information lives in the same place, companies can start to mine it for insights and use real estate in strategic ways. Plan for compliance, but prepare to enjoy some advantages as well.