Now that your company has transitioned to the ASC 842 Lease Accounting standard, what comes next? What do you do when the lease arrangement changes, or the facts and circumstances change after your initial adoption?

It’s important to remember the ASC 842 adoption process doesn’t represent an end goal. Instead, it is a new approach for monitoring and managing the company’s lease agreements. Companies must ensure they have accurate and complete data on all their leases, including the terms, payments, and options. They also should ensure that any changes to lease terms or conditions are accounted for and whether any leases need to be reassessed or remeasured to account for the remaining lease term accurately.

Common situations where a lease requires reassessment or remeasurement include:

As part of their review, companies must evaluate how to disclose lease changes to stakeholders such as investors, lenders, and auditors.

Lease modifications are often easy for lessees to identify because they require changing their contract with the lessor. In contrast, other events during the lease term can require the lessee to remeasure the lease liability and the associated right-of-use asset.

Reassessments are required when an event does not involve renegotiating the lease terms and conditions, but when facts, assumptions, or other circumstances change. For example, a lessee may change their decision about exercising an option within a lease.

How often companies should review their existing lease agreements depends on the number of leases they have and their complexity. In most instances, companies should review their lease agreements annually to ensure that they continue to comply with ASC 842 and any changes have been identified and accounted for properly. If a company has many leases, or complex leases, they may need to review their agreements more frequently.

If a lease is modified or reassessed, the underlying liability and right-of-use asset must be remeasured to account for the change. In some cases, the changes result in a gain or loss for the company.

Calculating these changes manually can be cumbersome if the finance teams rely on spreadsheets. In addition, having to copy or re-enter data manually can lead to errors and misjudgment.

Software tools such as LeaseCrunch can perform lease reassessments and calculate the journal entries and amortization schedules for the resulting right-of-use asset and lease liability remeasurements. This can help teams avoid errors and misjudgment caused by manual calculations.

LeaseCrunch offers a step-by-step workflow for entering the necessary data for the lease revision. It is flexible enough to manage changes in lease terms, payment streams, purchase options, early terminations, and incentives received.

For more information about our lease accounting services or lease reassessment and remeasurement, contact our team.

ASC 842 lease accounting is effective for calendar year-end entities for the 2022 fiscal year. The core concept of ASC 842 is the intention of the FASB to move previously off-balance-sheet operating leases to the balance sheet to better reflect the contractual liabilities owed under these arrangements.

Many venture-backed early-stage startup companies, or remote-enabled companies, have minimal or no operating leases. However, this does not mean ASC 842 concepts and provisions do not need to be considered.

The company doesn’t have any leases as of year-end, so there is no ASC 842 impact.

Truth:

This is a misconception because ASC 842 is required to be adopted as of the beginning of the period presented. Any leases outstanding as of 1/1/22 for calendar year-end entities would need to be included in the analysis of adoption and calculation of adoption entries.

The company has no operating leases and never has, so there is no ASC 842 impact.

Truth:

While the absence of traditional operating leases for office space or equipment results in no impact of adoption related to those types of leases, ASC 842 requires entities to evaluate whether there are embedded leases that were not considered under prior guidance. The FASB Master Glossary defines a lease as:

“A contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.”

Many companies that do not have office leases may still have embedded leases with service providers that may need to be accounted for. In many cases, agreements with cloud providers for designated servers or server space (data centers and colocations) qualify as embedded leases and require capitalization.

Related-party leases are evaluated the same way under ASC 842 as old lease accounting standards.

Truth:

ASC 842 requires that leases entered into with parties related to the company that are under common control are required to be assessed based on the written contract terms, regardless of the intent of the terms.

A related-party lease whereby either party may terminate the contract for convenience with no significant penalty would not have commercial substance and would not be a lease under ASC 842 as the terms are not enforceable over the specified terms. This is a change from prior guidance whereby related-party leases were evaluated for their economic substance above the legally enforceable terms and conditions.

ASC 842 impacts the balance sheet only and has no other significant effects after adoption.

Truth:

Companies should be diligent in considering the impact of adoption to reporting to external parties, especially banks that require financial covenant compliance, and plan proactively to inform stakeholders of any anticipated impact. Impacts on accounting and disclosure of deferred taxes should also be considered.

Companies should also ensure policies and procedures are put into place to account for new leases and contracts and any lease modifications as they occur.

Make sure to review all lease agreements, amendments, and related documents carefully and keep any changes in writing. Related-party leases should also be evaluated to ensure the contract terms in the executed lease properly reflect the intended use. 

These are just some of the many nuances in applying ASC 842 completely and accurately to ensure GAAP compliance for technology and startup companies. If you have questions, contact our team to understand the impact on your company.

As organizations consider sale-leaseback transactions, they must understand the financial reporting implications under the new lease accounting standard, ASC 842.

A sale-leaseback transaction typically occurs when an organization sells an asset, such as real estate, and immediately (or soon thereafter) leases the asset back from the purchaser. The organization that sold the asset is now a lessee, and the buyer is a lessor.

Sale-leaseback can be a useful tool for companies that need to raise capital quickly. However, it’s important to weigh the pros and cons carefully before deciding if this strategy is right for your business.

Organizations pursue sale-leasebacks for potential benefits that can include freeing up cash for operating or investing while maintaining the use of the asset, strengthening their balance sheet by using a less-costly form of financing than a debt facility, and allowing management to concentrate on their core business operations instead of worrying about maintaining fixed assets.

For buyer-lessors, these transactions can provide income over the lease term, as well as the potential to generate further returns by investing the lease income.

Potential disadvantages that sellers-lessees need to evaluate include the potential recognition of capital gains, an increased lease liability, and the removal of the sold asset from the balance sheet. For the buyer-lessor, the primary risk is potential payment default by the lessee.

The first considerations in accounting for sale-leaseback transactions are determining whether a contract exists and whether the transfer can rightfully be considered a sale. Under the new guidance, these factors depend on the following criteria outlined in Topic 606, Revenue from Contracts with Customers:

Under Topic 606, the transfer of control is defined by the buyer-lessor accepting the asset and assuming: Legal title, Physical possession, The risks and rewards of ownership, and An obligation to pay for the asset

The existence of a leaseback does not prevent the buyer-lessor from obtaining control of the asset. However, the buyer-lessor is not considered to have control of the asset if the leaseback would be classified as a finance lease or a sales-type lease.

Similarly, an option from the seller-lessee to repurchase the asset would preclude accounting for the transfer of the asset as a sale unless both of the following criteria are met:

If the transfer of the asset is determined to be a sale, the seller-lessee should:

In a sale and leaseback transaction, the sale price might be more than the fair value of the asset because the resulting lease payments are above a market rate; conversely, the sale price might be less than the fair value because the lease payments are below a market rate.

That could result in the misstatement of amounts for the seller-lessee and the buyer-lessor. In this case, the purchase price of the asset should be adjusted if the sale and leaseback occur at other than a market rate.

Whether a sale and leaseback transaction occurs at fair value is determined by the difference between either of the following (whichever is more readily determinable):

If the sale-leaseback transaction is not at fair value, the asset’s sale price should be adjusted on the same basis the entity used to determine the transaction was not at fair value. The adjustment to the sales price should be accounted for as follows:

Companies that have not yet adopted the new lease accounting standards can elect the package of practical expedients available during the transition and not reassess expired or existing lease contracts, assuming they have been correctly accounted for previously.

For more information about our lease accounting services or sale-leaseback accounting, contact our team.

If you own a business, then you have likely heard the buzz around the new lease accounting standard ASC 842 and the significant impact it will have on the way you record leases. For construction and other lease-heavy industries, we can expect to see major changes in not only balance sheets, but how investors, sureties, and lenders use this pertinent information to assess businesses.

In fast-paced industries like construction, analyzing accounting standards and tracking leases understandably fall low on the day-to-day priority list. However, proactive planning will be key to successfully implementing the new lease standard while ensuring your bonding and financial lending remain unaffected.

Running a business in today’s globalized world often results in receiving attention from domestic and international investors. This has led to a need for investors to have consistent standards with which to compare businesses. The new lease accounting standard ASC 842 is an effort to bridge one of the largest inconsistencies between the U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).

Under current GAAP, some leases are recorded on the balance sheet and other leases are simply disclosed in the footnotes. The new lease accounting rules will require that all leases over one year be recorded on the balance sheet. The increase in liabilities listed on the balance sheet will have an inherently negative effect on how those numbers are perceived.

Lease-heavy industries should start collecting their leases as soon as possible. For construction companies, leases include equipment, trucks, storage and yard space, and office facilities. All of these leases will need to be collected and have their terms identified and values recorded on the balance sheet. For facility leases not previously recorded on the balance sheet, the values must be recorded as a “right to use” asset at their present value of the lease payments.

To obtain a line of credit or term loan through a bank, a business must maintain certain financial metrics. This could include a minimum working capital or a maximum debt-to-equity ratio. The bank uses these ratios to determine the amount of equity and, therefore, risk you have in the business as well as measure the company’s ability to make payments on time — both of which greatly influence a lender’s decision-making process. Sureties use many of the same ratios and financial metrics to determine a construction business’ bonding capacity.

Since these ratios will be negatively impacted by the increase in liabilities on the balance sheet, it’s best to consult with your bank and surety now so they understand the changes to come. This will allow time to make any necessary adjustments to previously agreed-upon ratios.

Your CPA can help facilitate these conversations and help clear up any confusion regarding your balance sheet. A CPA can also proactively work with your bank and surety to create a pro forma of what your balance sheet will look like once your leases are recorded.

Considering the magnitude of these changes, it’s best to start preparing as early as possible, be extra cautious and bring in a professional if needed. Act early to get the most flexibility and cooperation from your bank and surety and make necessary adjustments. If your business is particularly lease-heavy, you may consider the help of a software package to help track your leases and automatically calculate depreciation on the related assets.

Remember, the new lease standard will affect virtually every business in every industry. Questions, struggles, and successes will be widely shared throughout the construction community, particularly among public companies facing an implementation deadline of December 15. If you are a privately-owned construction business, pay extra attention to lender, surety, and investor reactions and learn from some public filings before the private company implementation date of December 15, 2021.

If you need assistance implementing the new lease accounting standard, contact our team or visit our lease accounting resource page for more information or upcoming events.

It’s no surprise that the long-awaited changes to lease accounting standards have caused quite the ruckus in recent years, particularly as businesses scramble to understand and implement the complex new rules. In addition to understanding the new rule’s impact on an operational level, it’s also important for businesses to prepare for the various tax implications that are likely to ensue.

In a nutshell, the new lease accounting standards (formally referred to as ASC 842) require businesses to record all leases greater than one year on the balance sheet. This will require businesses to collect and analyze their lease agreements to identify leases and ultimately separate non-lease components from lease agreements.

Affecting virtually every industry in the United States, the increase in liabilities on the balance sheet will inherently change how those numbers are perceived and understood. Public companies were required to implement the new standard by December of 2018, while the changes go into effect for private companies beginning December 15, 2019.

 Here are seven of the major areas impacted by the new lease accounting standard:

There’s no question that the new standards will affect nearly every business’ accounting methods. Businesses may need to revisit certain aspects of their taxes, particularly with respect to characterization of leases, timing of income under IRC 467, treatment of tenant allowances, and treatment of lease acquisition costs.

The new rules require operating leases to be recorded as right-of-use (ROU) assets with a corresponding lease liability, consequently grossing the balance sheet. This will result in additional recordkeeping to track book-to-tax items. Book and tax basis items need to be reconciled to ensure that deferred tax liability (DTL) and deferred tax assets (DTA) are recorded correctly. Note that this is a temporary difference that will reverse over the life of the lease term. Furthermore, valuation allowance may also need to be considered.

Many states consider a company’s property when determining the amount of income tax to be allocated to the state. Because the new standard requires ROU assets related to operating leases to be recorded on the same line item as underlying assets, property factors (such as plants and equipment) may appear to be increased on a company’s balance sheet.

Ultimately, this will affect state apportionment for companies with activity in states that include property factors when calculating apportionment percentage. In addition, it will also affect state filings where a net worth-based tax is implemented.

The new standard will affect companies with related party leasing arrangements, as transfer pricing arrangements may need to be revised to reflect the arm’s length standard. The arm’s length standard relies on financial ratios and profit level indicators, which may change when companies begin to record all leases on their statements of financial position.

In addition to its effect on state and local income tax, the new standard will also impact foreign country income tax. The extent of the impact will depend on the particular tax jurisdiction and how income tax is calculated within that country.

Depending on the tax jurisdiction, ROU assets may be considered tangible personal property and must therefore be included in property tax filings.

Going forward, companies must determine whether a state will treat a lease transaction as a taxable purchase.

ASC 842 will have a wide-sweeping impact on virtually every business, and it’s best to prepare for the changes as soon as possible. If you have questions about the new lease accounting standards, or want to learn more about the potential tax implications for your business, please get in touch with us.

As companies adopt ASC 842, selecting and estimating the discount rates embedded within their various leases will play an important role in their implementation as well as their accounting going forward.

These decisions can be complicated by common misunderstandings about the different types of discount rates available, as well as the potential implications to the organization’s balance sheet.

Note: The FASB released a proposed update in September 2021 allowing a lessee that is not a public entity to make the risk-free rate accounting policy election by class of underlying asset, rather than for all assets under lease. Under this proposal, a lessee will be required to use the implicit rate when it is readily determinable (instead of the risk-free rate), regardless of whether the lessee applies the risk-free rate election.

Questions? Contact us to discuss the best approach to determining an appropriate discount rate for your leases, or for other ASC 842 implementation questions.

One of the many determinations companies need to make as they implement ASC 842, the new lease accounting standard, is calculating the appropriate discount rate for their leases.

For lessees, selecting and estimating the discount rate will have an impact on the lease liability and right of use asset (ROU) on the organization’s balance sheet. There are several options, each with potentially different outcomes, so making the most appropriate choice for your organization is a critical step in the process. Generally speaking, a lower discount rate results in a larger liability as there is less of an interest component to the calculation.

This is defined as the interest rate on a given date that generates the aggregate present value of the lease payments, and the amount a lessor expects to derive from the underlying asset following the end of the lease term.

To determine the implicit rate, the lessee needs to know some of the assumptions used by the lessor in pricing the lease. This includes the underlying fair market value of the asset under lease, the estimated residual value of the underlying assets at the end of the lease, and any direct costs that may have been deferred by the lessor. In many cases, this choice may be impractical because much of the information needed to calculate the implicit rate is not readily available to the lessee.

This is defined as the interest rate a lessee would have to pay to borrow, on a collateralized basis, an amount equal to the lease payments over a similar term and in a comparable economic environment. Among the ways to calculate an IBR are using your rate on existing debt or recent loan; the borrowing rate of similar entities with comparable credit risk; or an interest rate quoted by your lender if you were to borrow funds to purchase a similar asset.

The RFR is the rate of a zero-coupon U.S. Treasury instrument using a period comparable with the lease term. This provides a practical expedient alternative for private companies.

Making this decision became a little bit easier in mid-September as the Financial Accounting Standards Board (FASB) gave private companies and nonprofit organizations flexibility in choosing the discount rate used in calculating the value of their operating leases.

Under FASB’s revised guidance, an entity can choose between a discount rate such as an IBR and a risk-free rate for its leased assets.

The FASB also gave entities the option of selecting different discount rates for various classes of leases, instead of applying the same discount rate to all operating leases. This gives organizations the flexibility of calculating an IBR for high-value leases, such as real estate, and applying an easy-to-determine risk-free rate for low-value leases such as office equipment.

Lessees are required to disclose information about any significant assumptions or judgments to apply ASC 842, and this may include how they determined the discount rate for their leases. In addition, if a lessee elects the accounting policy to use the RFR, they should disclose this policy, assuming it is considered to be a significant accounting policy.

To learn more about choosing a discount rate or other aspects of your lease accounting implementation, reach out to our experts for help.

Private companies and nonprofits will soon be subject to the ASC 842 lease accounting standard. Adopting this standard is effective for annual reporting periods ending after December 15, 2021. For calendar year-end companies, the effective date is January 1, 2022. For companies with a fiscal year-end, the effective date would be the first interim period after their fiscal year-end (i.e., the effective date for a fiscal year-end of June 30, 2022, would be July 1, 2022).

Review your general ledger accounts, looking specifically for fixed recurring and variable payments for existing leases and other contracts, which may have embedded leases under the new standard. Embedded leases are determined by the lessee’s use and control over any identified assets in the agreement. The most common embedded lease is typically within an IT service contract if it specifies underlying hardware that may be included.

Create an inventory of your contracts and review key information in those contracts, including fixed payments, indexed payments, renewal options, residual guarantees, initial direct costs, lease incentives, and options to purchase. In addition, payments to the lessor may include fixed non-lease payments such as insurance, maintenance, and taxes. There is a policy election that allows these costs to be included should a company desire to do so.

Fixed lease payments are those recurring payments that are the same amount each month, including payments with a fixed percentage increase based on specified dates or anniversaries. In contrast, a payment based on an unknown future rate, such as the CPI index or lessee’s sales, are considered variable. These are treated differently under the new standard.

Policy Election Options:

 Practical Expedients Options:

Separate Election

Financing Lease

* Example is a 60-month equipment lease with monthly payments of $500 with an option to purchase of $100, which the lessee intends to exercise.

Operating Lease

* For example, an office lease with 60 monthly payments of $4,000 (for a total of $240k) would not be considered a major portion of a $2m building’s economic life of 30 years.

For more information or help with your ASC 842 adoption requirements, don’t hesitate to contact us.

As a business owner, you likely started your business because of a great product and a passion for your craft. Whether innovating the production of chocolate or sharing your family’s bread recipe with the world, analyzing accounting standards and tracking leases are probably low on your list of leisure priorities.

For years, we have been hearing about how the new lease accounting standard is going to shake up the way businesses record leases. For the Food and Beverage industry in particular, this new standard will have a significant effect on not only your balance sheet but the way banks and investors view your business.

In today’s globalized world, investor portfolios include domestic and international businesses. This has led to a need for consistent accounting methods to compare businesses using the same standards. The new lease accounting standard is an effort to bridge one of the largest gaps between U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).

Under current GAAP, some leases are recorded on the balance sheet, and other leases are just disclosed in the footnotes. The new lease rules will require that all leases over one year be recorded on the balance sheet.

For businesses that tend to be “lease heavy,” it’s best to start planning for these changes sooner rather than later. For Food and Beverage businesses, leases include everything from facilities and manufacturing equipment to trucks and delivery vehicles. For companies with restaurants and storefronts, leases include suites, mall stands, and retail space. Businesses will need to collect all of their leases, know the terms, and record the values on their balance sheets.

Facility leases not previously recorded on the balance sheet must now be recorded as a “right to use” asset at the present value of the lease payments. This balance sheet loading is going to have a significant effect on how statements are viewed and understood.

Suppose you have a line of credit or term loan through a bank. In that case, the bank will typically require the business to maintain certain financial metrics, such as minimum working capital or maximum debt-to-equity ratios. These ratios indicate how much equity you have at risk compared to how much others are at risk based on what you owe.

Additionally, it measures the company’s ability to make payments as they come due. The resulting increase in liabilities will negatively affect both ratios. It’s a good idea to consult with your bank and adjust your ratios so you are not out of compliance with your loan covenants.

Start early, be meticulous, and seek professional guidance. If your business is particularly lease-heavy, there are software packages that will help track lease details and automatically calculate depreciation on the related assets.

Remember that you are not alone in the food and beverage community or the community. For public companies, this standard is effective for fiscal years beginning after December 15, 2018. Private companies would pay attention to lender and investor reactions and look at examples of public filings before the private company implementation date the following year.

Your CPA can help facilitate conversations with your bank and investors. Lending institutions will see a significant shift in how they view balance sheets, and CPAs can help clear up the confusion. Work with your bank and CPA to create a pro forma of what your balance sheet will look like with your leases recorded. It’s best to have these conversations well in advance to maximize the flexibility of your banks and lenders. Contact us to get help today.