10 observations for private companies’ lease accounting

The lease accounting standard requires companies to record on their balance sheets leases embedded into contracts. This means private companies need to determine their obligations arising from lease and service contracts that involve the use of fixed assets.

Many companies underestimate the effort it takes to collect lease information and organize it in a uniform format. They might be surprised by the number of things they lease – from coffee makers and copy machines to building space and cars. The problem is that companies often are not tracking smaller assets (like printers, for example) because the dollar amount isn’t as significant as it is for other assets such as real estate. The value of a handful or more of smaller, seemingly insignificant items adds up, however. And tracking these and other leased items takes time.

The new lease accounting standard adds more requirements for accounting teams. This might mean adding accounting resources or outside advisers to assist with the implementation and ongoing data gathering, accounting, and financial reporting for leases. How far to stretch the budget depends on the organization. For example, if a company has 20 office leases and each is a 20-year lease, one accountant might suffice. But if a business has hundreds of leases and anticipates more leased assets, it might need to consider adding to the accounting team. Remember, the lease accounting software a company chooses is an enabler, not an end-all solution.

Prior to applying ASC 842, entities accounted for related-party leases based on their economic substance, which can be complex given the unique nature of related-party leases. In contrast, ASC 842 requires entities to account for related-party leases based on their legally enforceable terms and conditions, which is intended to simplify applying the leases guidance and will be a change in practice for many entities. However, stakeholders have raised questions about how to apply this guidance. As of the time of this publication, the FASB has proposed amendments to the standard to ease the application of the legally enforceable terms and conditions concept and to amend the subsequent accounting for leasehold improvements in an effort to reduce diversity in practice.

The new leases standard comes with a package of three transition practical expedients that companies can use to ease their initial application of the standard. Most companies likely will elect to use the package of transition practical expedients, namely so that they do not need to reassess the classification of leases existing at the transition date. The practical expedients allow the same classification of leases assuming they were originally classified correctly under ASC 840.

Changes in the way (and where) people work in recent years have drawn many companies to either reduce their real estate risk by entering into sale and leaseback transactions or reduce their leased real estate footprint. In either case, applying ASC 842 changes the accounting for these events.

For example, ASC 842 has less restrictive rules relating to sale and leaseback transactions involving real estate. Consequently, more sale and leaseback transactions involving real estate are likely to result in gain recognition. However, entities should be aware of guidance involving off-market terms. For example, often in these transactions, the sale price and leaseback rentals are negotiated together – that is, if the sale price is above fair value, the corresponding lease payments also typically will be above market rent terms. When performing their accounting analysis, companies should not assume that either the selling price or lease payments (or both) are at market terms.

Private company lessees that expect to downsize their lease footprint should be aware that they might need to consider if ROU assets (along with other assets in an asset group) have been impaired by applying guidance in ASC 360 relating to testing long-lived assets for impairment.