This New Lease Accounting Standard Is About To Have A Big Impact On Balance Sheets
In February 2016, the Financial Accounting Standards Board issued an update known as ASC 842 that, among other changes, brings most leases onto the balance sheet. Now, all of a company’s operating assets — including property, equipment, planes and cars — must appear as a risk.
Overall, ASC 842 is estimated to bring $3 trillion of lease liability onto S&P 500 balance sheets — the total value of operating leases that the International Accounting Standards Board says U.S. public companies are committed to. When private companies are considered as well, the value is enormous. This will give investors a lot to mull over.
“Previously, a large multinational corporation would not have had to capture all its leases around the world on its balance sheet,” Yardi CRE Solutions Lead Turner Levison said. “This could amount to millions of dollars of liabilities, with varying levels of risk that could be very misleading for investors. Now, all future rent payments, as well as equipment rental and so on, are used to calculate the net present value of risk that needs to sit on a company’s balance sheet.”
Public companies had to change their accounting practices in 2018. For private companies, the deadline is December. This could spell out an awful lot of work.
“A lot of companies are behind on this,” Levison said. “There are a lot of companies with a huge number of leases to figure out. Doing this on a spreadsheet is a disaster.”
Levison added that there is software that can automate the process, such as Yardi Corom, which is a purpose-built solution for lease administration and accounting. Outside of using these tools, he laid out three key things a company needs to consider before the December deadline.
Understand Which Leases Fall Under ASC 842
Under ASC 842, a lease is defined as a contract that conveys the right of use of a physical, distinctly identified asset for a specific period of time in exchange for payment. All operating leases — as opposed to finance leases, which are comparable to purchase agreements — must now be accounted for on balance sheets.
“This will make a big difference to all businesses with a large real estate footprint, including retailers and restaurants as well as multinational businesses,” Levison said. “Crucially, a business needs to understand not only which leases this affects but which component of each lease — and then make the necessary calculations.”
Create A Companywide Lease Portfolio
Companies will likely need to create a full lease portfolio for the first time to comply with the new standard, Levison said. This could require liaising with several departments in the company to pull together all the data, including procurement and accounting. Many older leases, for example, may be hard to track down and involve a significant amount of paperwork.
“A good place to start is to identify a person in each department who can take responsibility for collating the information they have access to,” he said. “For example, vendor contracts, lists of recurring payments, lists of leased assets. Once all the information is together, you can get a clear picture of where you’re at.”
Levison highlighted how the sheer volume of data will require significant work to get it into shape. There could be inconsistencies regarding how assets are accounted for, as well as human error in calculations or when data is moved from one source to another. Pulling all information into a central repository could take away a lot of the potential risks.
Understand The Impact Of Increased Liabilities
Once lease liabilities are recorded, this will likely cause a material change to balance sheets. Levison highlighted the importance of understanding the impact this could have in several ways. Firstly, debt covenant agreements use metric calculations that include a company’s liability balances.
“A company might need to speak to a bank or other lender about whether any changes to agreements need to be made,” he said. “Having these types of conversations now will make things easier in the long run, reducing the risk of surprises.”
While generating the full lease information required might be a lot of work, it could be highly useful for the future, Levison said. Post-pandemic, many companies are assessing their workspace requirements and looking for ways to save money or meet employees’ evolving needs. Getting lease data into one piece of software could make creating that picture a lot simpler in the long run.
This article was produced in collaboration between Yardi and Studio B. Bisnow news staff was not involved in the production of this content.
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