For many private companies, the opening months of 2023 may present a series of accounting challenges, stemming from a change in lease accounting guidelines. In 2016, the Financial Accounting Standards Board (FASB) replaced ASC 840 with ASC 842, a set of new rules for how organizations should report leases on balance sheets, which is generally believed to be the most significant change to lease accounting since 1976.
ASC 842 divides leases into two categories: finance leases and operating leases (the old rule made a similar division, though finance leases were termed “capital leases”). The new rule’s most significant change is that companies must now record all leases that exceed 12 months as assets and liabilities. Previously, under ASC 840, companies were allowed to leave operating leases off their balance sheets. Now, however, for each of their operating leases, companies must list a lease liability, which is calculated as the value of future payments, and a right-of-use asset, which indicates the right to control an asset for the duration of the lease. As we will see, it will be no small task for many firms to comply with the new rules.
ASC 842 was originally scheduled to go into effect for private companies beginning in 2020. However, the COVID-19 pandemic delayed its implementation. Ultimately, calendar year-end privately held companies were mandated to adopt ASC 842 for reporting periods beginning on January 1, 2022, while privately held companies with fiscal year-ends had to do so for reporting periods beginning December 15, 2021. That means that this year, all private companies will be subject to the new ASC 842 accounting standard.
The goals behind adopting ASC 842 are admirable — the FASB believes the new rules will allow investors a fuller, more complete picture of companies’ financial situations by reducing the number of off-balance sheet items. But this transition period will also undoubtedly pose difficulties for accounting professionals and finance departments. Let us dive into why this is so.
Since they were not previously required to do so, many companies do not have a centralized record of their leases. Putting this together will not be easy for most organizations. While we typically think of leases in terms of real estate, the reality is that companies lease all kinds of assets — equipment, phones, computers, vehicles, and more.
Furthermore, these lease agreements are often buried away in other kinds of contracts, making them difficult to track and classify. This means that even companies with relatively simple real estate portfolios — for example, those that lease just one office space — might, in fact, have lots of leases to report, while those with more complex real estate portfolios may find themselves overwhelmed by the task of identifying, classifying, and recording all their leases on their balance sheets. Companies will have to decide whether they want to retroactively adjust their financials for previous years to comply with ASC 842, or leave them as is.
If your organization is encountering difficulties as it works towards compliance with ASC 842, then you may want to consider seeking external help. Many firms are hiring outside experts to assist them in identifying and reporting their leases. Whether the task ahead appears simple or complex, it is always a good idea to call on trusted industry professionals. To that end, our team can bring decades of valuation experience working with all kinds of real estate companies to help you successfully comply with ASC 842.