Private Companies and NFPs:
6 Lease Accounting Steps to Take in 2022
As you may already know, in 2016 the Financial Accounting Standards Board (FASB) changed the way companies need to account for their leases under U.S. GAAP. The updated standard, ASC 842, went into effect for public companies in 2019 and must be adopted by private companies and non-profit (NFP) organizations this year, with an effective date in 2022.
Overview of ASC 842 for Private Companies & Nonprofits
In general, leases and lease components are no longer “off balance sheet items.” Companies must record lease assets and liabilities in their financials, moving these from the footnotes to actual line items on the balance sheet.
Private companies and non-profit organizations have the advantage to carry forward lessons learned by public companies that have been working on this matter for a few years. To start, public companies learned that adoption took dramatically more time and effort than they anticipated. They also found they had to significantly adjust their approach, because this wasn’t going to be a one-off project; this was really about developing a system for ongoing annual compliance.
What We’ve Learned & Best Practices
Here are a few best practices leaders of private companies and tax-exempt organizations need to know about these lease accounting changes:
1. Relearn what qualifies as a lease
The definitions for finance lease and operating lease have shifted, and we aren’t necessarily talking about the rent for your facilities.1 Companies were surprised to learn that contracts for such things as storage space, long-term supply agreements, delivery services, and software contained embedded lease components. For example, the coffee machine in your break room could potentially be a lease under the standard. It’s critical to understand the new material qualifications inside and out.
2. Commit enough time to find all your leases
Conduct a detailed review of all contracts (yes, all of them). Track these documents, determine if they contain an embedded lease component, and note the details for each. Essentially, you’ll create a right-to-use asset and lease liability listing. You’ll be surprised by the quantity and diverse nature of your leases. Most companies we’ve worked with still miss some lease components in vendor agreements, so it’s potentially worth engaging a consultant.
3. Make key accounting decisions and document them
Next, you’ll translate all this into your accounting and make some treatment decisions. The determinations you need make include but are not limited to:
- The lease term, and if you should include renewal options (For example, if an original lease is for 10 years, and you have a 5-year renewal option, is this a 10-year lease or a 15-year lease?)
- What discount rates were used to calculate lease asset/liability
- Whether or not to combine or separate payments for lease and non-lease components when calculating lease asset/liability
- Whether or not to use first-year implementation elections (aka practical expedient elections) when calculating lease asset/liability
- How to factor in lease modifications and changes, like COVID concessions
It’s important to note that these determinations must be made by management, not by your auditor if you have one.
You may be wondering how you can navigate some of these decisions. Something important to keep in mind is that your auditors can consult with you on the accounting standard and answer some questions. However, there are some things that your auditors can’t assist you with in order to maintain their independence. (More on this topic below.)
4. Form a multifunctional team for implementation and ongoing compliance
Include everyone who works on contracts, such as HR, operations, facilities, and IT. This will help with the extensive and time-consuming initial contract review. Invest heavily in educating everyone on the ins and outs of the new standard that are relevant to them. For example, does your IT Director understand what qualifies as an operating lease when they are renewing the printer contract?
Once you’ve completed the initial implementation phase, designate a key finance team member to oversee ongoing compliance and to act as a liaison with other operations functions around vendor agreements. The optimal situation is if accounting is looped in while contracts are being negotiated, not only dealing with contract terms after the fact.
5. Discuss in advance potential balance sheet changes and their impact
Talk with your bank, investors/donors, and others about how your financials might be changing. For example, you might need to ask your bank to revisit your covenants or have a conversation with your stakeholders about the differences they’ll see on the financials. The goal is to have no surprises and be able to strategize ahead.
6. Invest in specialized software
Many companies and organizations will be tempted to track everything in a spreadsheet. But we’ve seen that specialized software can do a lot to support initial implementation. Better yet, it can effectively support ongoing compliance and tracking. If you have more than 10 leases, we suggest looking into lease accounting software with OCR scanning capability, so you can extract pertinent contract terms for your calculations and provide an audit trail. Remember, this is not a one-time exercise; you will need to monitor and review contracts annually.
Schedule a Consultation Soon
The time to start your new lease accounting standard implementation is now. The Seiler team is here to help. Contact your Seiler advisor to schedule a consultation as soon as possible.
[1] For this article, we don’t have time to go into the details of the technical definitions, but we want to emphasize that it’s important to relearn the qualifications. We will also only focus on domestic accounting and will not be able to address IFRS 16.