ASC 842: What, Why, When & How?
What is ASC 842 Leases?
Known as Accounting Standards Update (ASU) 2016-02, and finally published by FASB in 2016 with an effective date of 2019, Topic ASC 842 is the new “leases” standard initially planned and drafted alongside IFRS 16 from IASB. The standard was designed to update and replace ASC 840 particularly addressing the issue of operating leases being used for off-balance sheet financing. A situation that very frequently resulted in assets key to a business together with the contingent associated liabilities being accounted for as revenue expenditure and not appearing on-balance sheet. Closing the loophole of “off-balance sheet” finance was the main reason for the creation of Topic 842 and though it took more than 10 years to finalise, it is with us now following these milestones –
- 2005 – SEC Targets Off-balance sheet financing
- 2006 – Joint “leasing” project initiated by IASB & FASB
- 2009 – FASB & IASB issue “Leases: Preliminary View”
- 2010 – First “leases standard” Exposure Draft published
- 2013 – Second “leases standard” Exposure Draft published
- 2016 – January – IASB publishes final standard IFRS 16 “Leases”
- 2016 – February – FASB publishes final standard ASU 2016-02 “Leases”
Why was it necessary?
The use of operating leases for off-balance sheet financing allowed companies to omit certain lease assets and associated liabilities from their balance sheets. Without careful scrutiny stakeholders, lenders, potential investors and even management could misinterpret the debt-to-equity ratio – particularly with regard to its financial health and comparative performance against other companies within the same sector. In 2016, the International Accounting Standards Board (IASB) estimated that public companies using either the IFRS Standards or US GAAP had lease liabilities totaling $3.3 trillion of which 85% was not recorded on balance sheets. There existed then major airlines carrying millions of passengers over millions of miles but with no aircraft on their books! Under ASC 840, operating lease expenses could be accounted for in P&L and the only disclosure of any associated committed liabilities was in the footnotes of corporate financial statements. Companies didn’t own the assets but the lessors of those assets and owners of the associated liabilities were creditors alongside other lenders who did have debt recorded on the balance sheet.
When is ASC 842 effective?
Impacting any business that enters into a lease, save for some designated exemptions defined in ASC 842, the standard was to be applicable for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. This date still applies for
- Public business entities,
- “not-for-profit” entities that have issued or are conduit bond obligators for securities that are traded, listed or quoted on an exchange or over-the-counter market;
- and employee benefit plans that file or furnish financial statements with or to the Securities Exchange Commission (SEC)
For all other entities, the standard was to be applicable for fiscal years beginning after December 15, 2019 and interim periods within fiscal years beginning after December 15, 2020.
Though early implementation is still permissible, following the ASU 2019-10 and then ASU 2020-05 official announcements of implementation delays the effective deadline dates for ASC 842 are now –
- for public NFP entities that have not yet issued financial statements (or made them available for issuance) reflecting the adoption of Leases, fiscal years beginning after December 15, 2019, including interim periods within those fiscal years
- for “all other” entities – fiscal years beginning after December 15, 2021 and interim periods within fiscal years beginning after December 15, 2022.
How is ASC 842 Implemented?
Remember that Public Entities have already or should have already transitioned to and been compliant with ASC 842 for some 2 years. Their experience will have been shared with their auditors and specialist lease accounting software vendors such as Innervision. Simply put it has all been done before and it is better to embark on the transition sooner rather than later harnessing the knowledge that is now available –
- Get a team together with an owner for the project
- Get the whole business involved and keep them informed
- Size the resources and time required and investigate available technology
- Legal, procurement, treasury, real estate, IT and others will need to be involved
- Find and analyse all contracts and identify leases and lease components
- Understand the standard and its expedients and exemptions
- Speak with similar companies facing the challenge
- Perform impact modelling to reflect the effects that different options may have
- Communicate the impact to stakeholders, investors, lenders, auditors and staff
- Transition, implement and comply
A critical component of any successful transition to ASC 842 is the deployment and implementation of dedicated lease accounting software that has been developed specifically to address the accounting and financial reporting requirements of the new standard.
Innervision’s solution, LOIS Lease Accounting (LLA), is a proven cloud-based lease accounting application that is used by over 160 corporate entities worldwide, most of which have been audited at least once since implementing the system. These entities depend on the solution to help ensure compliance with the new accounting standards and ongoing financial reporting.
With LLA you can:
- Calculate and track Right-of-Use (ROU) assets and liabilities
- Perform lease modifications, in-life changes and remeasurements
- Facilitate accurate financial reporting and accounting
- Run amortization schedules, journal entries and disclosure summaries
- Record a robust and accurate audit trail
For more information, view our lease accounting software brochure to see how such a solution will help with your compliance project. Alternatively, if you like a more in-depth view of the software, request a free demo today.
Disclaimer: this article contains general information about the new lease accounting standards only and should NOT be viewed in any way as professional advice or service. The Publisher will not be responsible for any losses or damages of any kind incurred by the reader whether directly or indirectly arising from the use of the information found within this article.