ASC 842 Effective for Private Companies – Now What?

Setting the stage

On Nov. 11, 2021, the Financial Accounting Standards Board (“FASB”) met, discussed and unanimously voted against an additional deferral of the effective date of Accounting Standards Codification Topic 842, Leases (“ASC 842”) for private companies. The standard was effective for nonpublic business entities for periods beginning after Dec. 15, 2021. This means that the effective date of ASC 842 for calendar year-end companies was Jan. 1, 2022 of this year. 

For those private companies that are embarking on their implementation efforts, there is still time. The first reporting requirements will be for the annual period in the year of adoption, with interim reporting requirements required the following year. 

This article highlights five lessons learned from the implementation efforts of those companies that that have already adopted ASC 842.

Lesson 1: Finding leases is not a straightforward process.

Completeness of the lease population is key to a successful implementation. Many companies have found this exercise complex as leases may have been tracked and maintained in disparate spreadsheets or databases and managed by different individuals. Further, some arrangements that met the definition of a lease–for example, certain technology agreements–may not have previously been accounted for as such. This added considerable time and judgment to identify embedded leases.

Leading practices to identify leases include surveying key stakeholders, assessing areas of risk to identify where leases may exist, examining contracts including service-oriented contracts that may contain leased assets, and reviewing expense activity and vendor spend. It is important to establish processes and procedures to not only identify the complete population of leases for transition, but to subsequently identify new leases as they are executed post adoption.

Lesson 2: Identifying, abstracting and maintaining the required data may be challenging.

A company’s lease population may include complex provisions, have numerous amendments or be written in a foreign language. Additionally, since lease agreements do not contain all of the data necessary to comply with ASC 842, certain key assumptions may require management judgment and estimates. 

Developing a comprehensive plan to identify, collect, organize and maintain the data necessary to meet the ASC 842 presentation and disclosure requirements is critical. This plan should include leveraging technology in combination with suitably trained and skilled individuals and performing data quality checks and controls.
 

Lesson 3: Systems and processes may need more attention than expected and desired.

Much more information than anticipated was needed to meet the recognition, presentation and disclosure requirements. While some companies may have had systems in place to account for leases where they are a lessor, many have found it beneficial to implement a new lease accounting solution where they are a lessee. The implementation of a technology solution often took longer than expected as the technology frequently needed customization to meet specific financial and management reporting needs, and the necessary testing often expanded the implementation timeline.

Enhancing existing processes and implementing technology solutions within a company’s environment requires time and proper planning, with the focus on determining the business requirements, identifying how to best integrate the changes into the company’s IT environment, testing the accuracy of the technology and training end users. 

Lesson 4: Applying the new accounting requirements may be complex.

The ASC 842 requirements depend on various assumptions and judgments, introducing a level of complexity in the areas of financial reporting. Companies found that not only was it important to understand the transition guidance and related expedients, it was also important that they know how to apply the overall accounting model to new arrangements. Some of the more challenging areas in the accounting itself have been (1) evaluating the lease identification criteria, (2) establishing the incremental borrowing rate, (3) determining the lease term, (4) evaluating lease classification, (5) measuring a lease on the basis of these key assumptions, and (6) complying with the new presentation and disclosure requirements. 

To address these complexities, it is vital that stakeholders are educated on the ASC 842 accounting requirements to provide for a successful implementation. Similarly, it is important to develop and document company-wide accounting policies for the relevant types of transactions under ASC 842. Finally, it is important to establish repeatable processes for determining the key assumptions and related management estimates as this will simplify compliance and provide audit evidence that supports the appropriateness of the amounts recognized in the financial statements. 

Lesson 5: Enterprise-wide stakeholder engagement is a key to success.

Implementation of ASC 842 is not an accounting-only endeavor. Including other departments such as legal, information technology, operations, accounting policy, controllership, procurement, treasury and tax in the ASC 842 adoption efforts is critical to a successful implementation. This not only allows for efficient implementation planning and execution, but also to helped identify opportunities for ancillary benefits.

It is important to develop a robust implementation plan that will be executed by a cross-functional team that will address the key attributes and requirements of ASC 842. A prevailing practice has been establishing a robust implementation roadmap detailing the adoption-related tasks across all affected functions. The implementation plan should be socialized with all relevant stakeholders, with changes and updates to the plan communicated with regular cadence. 

Bottom line

ASC 842 became effective for private calendar year-end companies on Jan. 1, 2022. It is important for key stakeholders that are involved in the implementation of the ASC 842 requirements to develop an implementation plan that includes the appropriate individuals throughout the company. It is similarly important to educate individuals throughout the company on what it means to be a lease under ASC 842 as well as the accounting and financial reporting implications of such conclusions.