Last year, among the myriad of economic and regulatory changes, the Financial Accounting Standards Board’s (FASB) new lease accounting standard, ASC 842 became effective for private entities and not-for-profits. This standard requires entities to record nearly all of their leases on their balance sheets. The shift is meant to increase overall transparency and limit off-balance sheet activities.
Taking the effort for transparency a step further, the FASB implemented a formal update to the standard in March 2023, requiring entities to record all lease agreements even if they are not bound by a formal contract. Directed primarily toward private and non-profit organizations, this update was to make sure no leases slip between the cracks – while formal contracts are the standard among large entities, that is not always the case for smaller organizations.
ASC 842: Adoption vs Compliance
Once the new standard has been adopted, you can check the box and move on, right? Not so fast. Adoption and compliance are two different endeavors. As organizations adopt the new lease accounting standard, in tandem, they should determine next steps for maintaining compliance post-implementation. Compliance with ASC 842 requires ongoing efforts to make sure all lease accounting practices meet the updated standard.
Here are five ways to maintain compliance after adopting the new lease accounting standard:
- Leverage the Knowledge Gained Through Implementation
Implementing ASC 842 was a heavy lift for many companies, but those efforts have paid off with a clearer view of their lease portfolio. Through learning about and adopting the updated standard, knowledge gained in the process can be leveraged to create more efficient processes for lease accounting and other business processes.
Companies are using the increased visibility to create more accurate budgets and forecasts, improve the structure of contracts, and make informed decisions around leasing vs. buying assets. Additionally, the adoption of ASC 842 has allowed companies to improve their risk management strategies by providing a clearer picture of lease requirements and enabling them to more effectively manage expirations and renewals.
While adopting ASC 842 was no simple task, the process has provided companies with valuable insights that can reduce errors, drive long-term success, and sustain compliance.
- Maintain a Complete Lease Population
During implementation, one of the biggest challenges companies faced was identifying their complete lease population. The need for this information does not change with Day Two accounting (the period after adopting a new standard). as companies must account for all of their leases as they continue to execute, modify, renew and terminate contracts. However, companies can leverage a lease accounting software to automate these processes, further improving efficiency and accuracy.
- Evaluate Workflows for Efficiency
Now that the new standard is in place, companies should take some time to evaluate their new workflows for efficiency. Looking back on 2022, the first year with this new standard, what can be learned? What should be done differently going forward? How can overall operations improve? Are there process improvement opportunities?
An automated solution may be the most efficient option, but if new policies and procedures need to be introduced to the team, any new technology should be paired with employee education and training. By reviewing their workflows, companies can identify areas for improvement and streamline their lease accounting process, both increasing efficiency and reducing the risk of errors to maintain compliance.
Adopting the new lease accounting standards is like following a whole new playbook. For many companies, everything changed after implementation and keeping up can be difficult. Documentation plays a key role in maintaining compliance.
Now that companies are no longer in the throes of implementation, to provide business continuity and preservation, it’s time to shift focus to accurate documentation of all processes and procedures related to lease accounting. Having this documentation in place will not only help with compliance, but also guarantees that there is a clear roadmap and record of lease accounting practices for future reference.
While updating processes and procedures, it’s a good idea to implement a policy around the frequency with which a company reviews its incremental borrowing rates (IBRs). IBRs are specific to a company, are based on a myriad of criteria, and can fluctuate over time. For instance, changes in market conditions and considerations like the company’s credit rating may affect a company’s IBRs.
By periodically reviewing their IBRs, companies can make sure that they are accounting for leases using the most current information available, leading to greater accuracy in lease accounting. By maintaining accurate and up-to-date IBRs, companies can improve their financial reporting and gain a deeper understanding of their overall processes.
- Moving Forward After Adopting ASC 842
While adopting ASC 842 was no simple task, the process has provided companies with valuable insights that can drive long-term success, and maintaining compliance post-implementation is essential. Adopting the standard was just the first step. Compliance is a path that companies must follow – now and in the future.
On this path to compliance, companies should prioritize changes that will streamline the lease accounting process, such as implementing lease accounting software. By applying what was learned through adoption, understanding its lease portfolio, and re-evaluating and documenting processes, companies can make sure they are properly accounting for all leases and meeting the requirements of ASC 842.
Emily Fish is the Director of Product Accounting at LeaseQuery