If your private entity has put off its shift to the new lease accounting standard adopted by the Financial Accounting Standards Board (FASB), you still have time. But if you're thinking that the process is going to be quick and easy, you're under the wrong impression. Further delays may leave you in the uncomfortable position of scrambling to catch up on a process that is more complex than many realize - especially if your operation includes a high number of domestic or international leases. The more complex the terms and structure of your leases, the more time you're likely to need to get your house in order.
Changes in ASC Topic 842
The changes that have been made to Accounting Standard Codification (ASC) Topic 842, Leases represent a substantial departure from the way that operating leases have been handled in the past. Where they'd largely been left off out of accounting procedures entirely, and disclosure left to notes about future commitments on financial statements, the new standard requires that almost all of the in-scope leases be recorded as right-of-use assets and lease liabilities on balance sheets, though leases with a term of 12 months or less at commencement date can be left off based on available policy elections.
One way or another, the potential impacts of the change can be profound. With leases included as assets and liabilities organizations may find themselves unable to qualify for credit, or out of compliance with existing financial covenants based on changes to their liquidity or working capital. It's for this reason that we are encouraging all those affected to plan accordingly and make sure that they have conducted a thorough analysis prior to implementation. Private organizations are to have transitioned to the new standard for fiscal years beginning after December 15, 2021, and for interim periods within fiscal years beginning after December 15, 2022.
Though each entity will address the shift in its own way, our recommendation is that a three-phase process be used, starting with a careful assessment of existing leases and creation of a roadmap for how to move forward; an examination of how compliance will impact the organization's financial statements; and finally reviewing the steps that they have taken to ensure that they have met all requirements and will continue to do so moving forward.
The most efficient method of addressing the task is to select capable professionals who can assess the details of the organization's leases in terms of payments, renewals, terminations, direct costs, and more and to determine a scoping approach. This will require a significant amount of effort, as none of the operating leases were previously on the balance sheet. Some may be embedded in other contracts. A smart approach will include a review of disbursement registers. Only after all leases have been identified and properly categorized can implementation be set into motion.
Once leases and contracts have been identified, each will need to be analyzed under the new standard to determine whether right of control is present, and therefore whether it needs to be identified as an asset. Documentation for methodologies and decisions will be required as to classification and whether practical expedients will be used. Journal entries and other accounting procedures will need to be instituted.
Once implementation has been completed and operational changes have been made, each entity will need to update its internal policies for the future, review its business systems to ensure future compliance, and create internal controls to ensure that the new procedures are being performed accurately and efficiently.
Key Takeaway
The more lease transactions in an entity's portfolio, the longer the transition is likely to take. Regardless of size, however, adoption of ASC Topic 842 will require a great deal of dedicated time, resources, and collaboration, and shouldn't be underestimated.
Putting the right team in place, breaking down the implementation into manageable phases, and enacting the necessary operational processes and procedures for compliance will be key to a successful transition.
About Frank Jenkins Jr
Frank Jenkins Jr. CPA is the managing partner of Adams, Jenkins & Cheatham, a CPA practice based in Midlothian, VA. Frank specializes in Consulting services, tax planning, audit & assurances. "I genuinely care about our clients because I have a personal connection with them." He is active in the community and belongs to the AICPA and the VSCPA.
