It’s auditing season, and finance professionals preparing for the annual audit are bringing the spreadsheets, expense reports, memos, and—most importantly—adopting new generally accepted accounting principles (GAAP) rules set by the Financial Accounting Standards Board (FASB).
ASC 842, the new lease accounting standard set by FASB, took effect for private companies and nonprofit organizations starting on December 31, 2021. It’s top of mind for many finance pros following the standard for the first time as they prepare for this year’s audit.
What’s new? The greatest difference between previous GAAP rules and ASC 842 is the recognition of lease assets and lease abilities by lessees for those leases classified as operating leases under previous GAAP guidelines.
“It impacts all leases. It’s the most impactful on what’s [considered] long-term leases,” Anthony Placencio, partner at audit, tax, and consulting firm RSM, told CFO Brew. “Anything over 12 months is the most impactful.”
Companies must be mindful of embedded leases, or leases most commonly buried within service contracts, Placencio said.
Placencio gave an example: A gaming company signs a service contract with a manufacturer to develop a million units of its new video game console. Under ASC 842, the gaming company could be required to report equipment being used to fulfill the order, or a warehouse for storage of unsold inventory as leases.
And, under ASC 840, both the equipment necessary to fulfill the order and warehousing would have just been reported as expenses.
Why the change? While FASB’s standards are constantly evolving, discussions surrounding the leasing standard have been occurring since as far back as the early 2000s, amidst the Enron scandal, RSM partner Kirk Rogers told CFO Brew.
“[It] is somewhat coming out of Enron, off-balance-sheet accounting and the notion of financial transactions that aren’t being put on the balance sheet,” Rogers said.
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Leases signed by companies, both real estate and otherwise, ranked high among transactions hidden from investors and auditors—especially since under ASC 840, the predecessor to ASC 842, only capital leases were required to be placed on the balance sheet.
What’s the impact? Publicly traded companies adopted this standard for reporting periods subsequent to December 15, 2018 and—more often than not—have ample resources to make such a transition seamless.
Dan Kennedy, partner at Kennedy Doyle LLC, a law firm in Rocky Hill, Connecticut, told CFO Brew that smaller, privately held companies are most likely to be affected by ASC 840.
“When you have a smaller, privately held company, this new regulation can really skew how your books look,” Kennedy said. “It’s not necessarily, in many lawyers’ and accountants’ view, representative of how the company’s actually operating because you have to reflect leases in a manner that doesn’t necessarily show the actual expense of that lease in real time.”
Lastly, Rogers says, companies with a sizable lease portfolio can expect to cough up substantial sums of money for a database to track their leases in the future.
“Beyond a handful of leases, it gets very challenging to deal with it in Excel and maintain the quality,” Rogers told CFO Brew. “You need a software to do it and there’s several top-shelf software that do it, but they’re not inexpensive.”
Sticker shock! It could cost $10,000 to obtain the software, and that’s before labor costs to adopt and implement the software into your finance and accounting department.—LR