The FASB (Financial Accounting Standards Board) keeps updating its standards and requirements based on different industries’ performance. This ensures transparency in the declaration of assets by the companies in the form of their quarterly and annual financial statements.
Following the accounting standards and their corresponding guidelines and compliance requirements is necessary for all firms to follow, whether registered and listed privately or publicly.
The latest update by FASB is that companies are now required to add their leasing assets to their balance sheets, which was not there before. Previously, companies used to add only company-owned assets to their balance sheets without properly indicating leasing assets. However, the FASB and IASB’s (International Accounting Standards Board) IFRS 16 have different standards for identifying and classifying leases on the balance sheet. While the FASB created a dual classification into operating and finance leases, the IASB declared all balance sheet leasing assets to be finance lease assets.
Moreover, many companies have been facing difficulties transitioning toward the new standard. However, for their convenience, a software system and resources are available to make it easier.
Transitioning from ASC 840 to ASC 842
ASC 842 is the upgraded lease accounting standard from ASC 840 issued by the FASB. The ASC 842 effective date may vary for companies according to their fiscal year closing date. However, there has been a request for a deferral period by the PICPA (Pennsylvania Institute of Certified Public Accountants) owing to the COVID-19 challenges, staffing shortages, and other operational alignments for a smooth transition to ASC 842.
Such challenges could result in new sources of finance leasing options and, following implementation dates of the ASC 842, could lead to pending balance sheet calculations resulting in debt covenant.
In addition, it adds pressure on accounting firms and CPAs for adoption, with many clients rushing to them at once to assist them in the implementation, leading to pipeline order issues and bottlenecks.
However, the board declined the request for deferrals for private organizations and nonprofit agencies. Therefore, companies must adhere to the set standards and adopt ASC 842.
ASU 2016-02 Concerning ASC 842
ASU 2016-02 was an accounting standard issued by the FASB in February 2016 detailing the lease accounting standard via ASC 842, which was the new section codifying the accounting standards. It ultimately superseded ASC 840 in terms of compliance standards.
Although ASC 842 has been updated many times over the years, ASU 2016-02 acted as a baseline for accountants to set new standards for following lease contract reporting guidelines that work for private and public sector companies.
The Joint Effort of ASC 842 and IFRS 16 to Set the new Lease Accounting Standards
The FASB and IASB’s IFRS 16 (released in January 2016) agreed to set the new lease reporting standards as a joint effort. However, while doing that, some fundamental differences between the standards emerged.
While ASC 842 continues to distinguish between the operating and finance lease assets, IFRS 16 reports lessee leases as finance leases.
Moreover, the IFRS 16 re-measures the lease liability every time the index changes or if the lease payments fluctuate at a variable rate by resetting. ASC 842 does not re-measure lease liability whenever the index changes or lease rates vary.
FASB’s ASC 842 does not exempt low-value assets and immaterial leases, while IFRS 16 does not recognize them in the balance sheet. Although IFRS 16 does address how companies can define their low-value assets.
ASC 842 allows private companies to use a risk-free rate to calculate their lease liabilities, while IFRS 16 does not provide specific guidance to private entities.
While operating activities include interest payments in cash flows under ASC 842, IFRS 16 requires reporting interest payments under the investing, operating, and financing activities.
Therefore, there has been a considerable difference between the two standards.
Implementing and Adopting the New Lease Accounting Standards
For effective implementation of the latest ASC 842 standards, companies would not only need to update their financial reporting standards but also their related processes and systems. The first step in implementation involves effective planning before the effective date. Without proper preparation, your company may suffer.
It may not be linear due to differences in the public and private sectors. Therefore, you must go through certain stages before fully adopting the new lease accounting standard. Although the implementation strategies may vary with time and different sectors, some experts’ recommendations with experience can help make the process seamless.
However, the basis for implementation can start with assessment and readiness. Here, you can analyze and assess your leasing assets and categorize them into finance and operating lease.
Next, you can introduce policies required for smooth implementation. It can include tweaking the lease agreement to include certain terms and conditions to make reporting easier. Other policies can include pre-planning your company’s leasing needs and categorizing finance and operating activities before leasing equipment, vehicles, or real estate.
The next step can be lease abstraction and data storage. The implementation phase must center on data readiness. After that comes solution implementation. The policies selected in step two will define the time it will take to implement them and subsequent solutions. The system tweak could be technical and functional with customized configuration. Therefore, the timing may vary.
The last stage could involve deployment and aftercare. Even after the implementation, ASC 842 could require significant changes based on the activities during deployment. Therefore, aftercare and review are necessary to ensure that proper systems are in place and that the implementation does not contradict any other standards.
Whether you own public, private, or nonprofit agency, you must stay updated with the latest accounting standards and regulations, including ASC 842. It is essential to keep up with it because you must start planning way before the effective date, which may vary for public and private entities.
In addition, ASC 840 clearly distinguishes the operating and finance lease options with a specific focus on private companies and considers immaterial lease and low-value assets. It would make reporting easier because now you can categorize your lease options.
Moreover, you do not have to re-measure your lease liability every time the index changes or the lease payments differ in each period.
Although there may be significant differences between ASC 842 and IFRS 16, companies must ensure proper implementation through five stages, which may differ or may take more time depending on the entity.
Nonetheless, you must ensure due diligence, introduce relevant policies and plan the implementation well before the effective date.