Bringing Leases into your Books
(Intro to ASC 842)

Accounting standards never stay the same. The Financial Accounting Standards Board (FASB) continuously evaluates and updates the guidance that companies must follow. One of the most significant updates affecting nonpublic companies is ASC 842, which requires bringing leases onto the balance sheet for lessees. These changes could substantially impact companies with balance sheet metrics and financial covenants.

During the 2010s, FASB initiated major accounting overhauls, including ASC 606 (revenue recognition) and subsequently ASC 842 (leases). Let us walk through the key changes and what they mean for your business.

The old standard: ASC 840

Under the previous standard (ASC 840), lessees classified leases as either operating or capital based on specific criteria. Capital leases required recognition of assets and liabilities on the balance sheet at the present value of future lease payments. Operating leases received simpler treatment – no asset or liability was required, and lease payments were simply recognized as expenses on a straight-line basis.

Key changes with ASC 842

The most critical change involves operating leases. Previously, these required no asset or liability recognition. Under ASC 842, companies must now recognize both an asset and a liability for operating leases, similar to finance lease accounting. This significantly impacts balance sheets for any company with office or real estate leases.

The implications are significant:

• Balance sheets will expand with new assets and liabilities
• Reporting of balance sheet KPIs may become skewed
• Unexpected violations of debt financial covenants related to liability ratios could occur

ASC 842 also revises what qualifies as a lease. Investors and audit teams now require companies to evaluate all arrangements involving physical assets to identify previously unidentified leases requiring accounting treatment.

Implementation timeline

Publicly traded companies have already been required to adopt ASC 842 for fiscal years beginning after December 15, 2018 (calendar year 2019). Nonpublic companies are required to adopt ASC 842 for fiscal years beginning after December 15, 2021 (calendar year 2022).

Many nonpublic companies face a “one-two punch,” having recently completed ASC 606 adoption. The 2022 implementation year will be intensive, requiring deep dives into lease identification and complex guidance navigation.

In our next article, we’ll dive into a few key tips on how to start the ASC 842 implementation process for your company, and why it’s important to begin sooner rather than later.

If part of a nonpublic company, how prepared are you for the new lease standard?