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New Lease Standard: Avoiding Potential Pitfalls and Challenges

Many organizations are halfway through adopting two of the largest changes in accounting standards of the last decade: revenue recognition (ASC 606) is behind us, and the new lease standard (ASC 842) is looming large before us.

Having successfully implemented the new revenue standard with little-to-no pain, it would be easy for companies to be lulled into a false sense of confidence that the new lease standard will, similarly, be a breeze. However, according to a survey from LeaseAccelerator, 75% of companies who have adopted ASC 842 found the new lease standard to be more complex or as complex as the new revenue standard. The fact that this standard has already gone into effect on January 1, 2022 for companies with calendar year ends adds urgency to this issue.

Companies that have adopted ASC 842 cite the following challenges:

Challenge Description
Complete Lease Inventory The critical first step to implementing ASC 842 is to meet with various members of your organization to identify your entire population of leases and centralize where they are tracked. Upon completing a deep dive into existing contracts, many companies have found they had several more leases than they realized. Had they failed to identify those additional leases during the implementation of ASC 842, those companies would have materially misstated their financial statements.
Lease Software We advise companies with 10 or more leases to utilize lease software rather than attempt to track in a spreadsheet.
Extracting Lease Data Extracting key data from your lease agreements includes:

  • Asset(s) being leased
  • Lease commencement date
  • First payment date
  • Termination date
  • Initial term length
  • Optional renewal terms
  • Payment frequency
  • Likelihood of exercising renewal options
  • Non-lease components
  • Applicable discount rate
  • Residual value guarantees
  • Payment amount
  • Escalating payments
  • Bargain purchase option
  • Sale-Leaseback provisions
  • Provisions for transfer of ownership
Incremental Borrowing Rate If the rate implicit in the lease is not readily determinable, and most are not, organizations will have to use the incremental borrowing rate (IBR). The IBR is the interest rate a lessee would pay to borrow on a collateralized basis for a similar term and amount. As finding the relevant data can be time consuming and determining the IBR for each lease can be a complex calculation, companies may prefer making an accounting election to use a risk-free rate for your entire portfolio of leases. The risk-free rate is the interest rate on U.S. treasury securities for the time period comparable to the lease term.
Journal Entry Most companies are using the modified retrospective approach for adopting ASC 842, which requires a cumulative-effect adjustment to retained earnings on January 1, 2022. Determining the initial journal entry can be a complex calculation depending on your leases.
Process Going Forward Given the amount of time and effort that will go into identifying a company’s lease inventory and extracting all key data from the leases during implementation, it is critical for companies to establish a new process going forward to ensure all new leases and lease modifications are captured in a timely way in a centralized lease inventory listing.

We continue to answer questions and guide companies through this process. If you have questions about the new lease standard, the potential impact to your organization, or if you would like to explore how to manage this adoption with reduced risk and increased efficiency, McKonly & Asbury’s experienced professionals are here to help. Please reach out to Daniel Sturm, Partner at (717) 972-5786 or click here to contact us. You can also visit our website to watch our webinar titled “ASC 842 Leases: Moving Forward and Implementation”.

About the Author

Brett Bauer

Brett joined McKonly & Asbury in 2011 and is currently a Principal with the firm. As a member of the firm’s Audit & Assurance Segment, he serves clients in the manufacturing and distribution industry. At McKonly & Asbury, Bret… Read more

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