When the calendar flipped from 2021 to 2022, your private company didn’t only enter yet another year. Instead, it entered when the latest Financial Accounting Standards Board (FASB) ASC 842 compliance standards went into effect. As such, you and your team will be expected to update your accounting processes or risk the frustration and expense of noncompliance during your next internal or external audit.
An overview of FASB ASC 842
Not quite familiar with the purpose of the FASB ASC 842 lease accounting standards? They replace the former ASC 840 lease accounting standards that have been intact for over a decade. ASC 840 was revised to ASC 842 to give more comprehensive visibility into a business’s financial obligations. Specifically, ASC 842 changes the way you disclose your leased assets. These can include assets such as equipment, vehicles, or real estate.
Under ASC 842, your leasing obligations are accounted for on your balance sheet rather than buried elsewhere in your financial statements. As a result, you ensure that any financial statement user reviewing your balance sheet can see the scope of your organization’s financial obligations. Ultimately, ASC 842 provides transparency into your organization’s fiscal risks — and your opportunities.
Suppose you’re handling ASC 842 requirements correctly. Anyone who dives into your financial statements should have a solid understanding of your company’s financial performance. As you can imagine, that can be a considerable advantage, particularly if you embark on an ambitious growth period.
How is FASB ASC 842 different from ASC 840?
ASC 842 was based on the principles of ASC 840. Accordingly, you’ll see a lot of similarities between the two accounting compliance standards. For example, with ASC 840, capital finance leases were listed on the balance sheet as compliant. The issue was many companies would have operating leases. These were not required to be on the balance sheet under ASC 840. Under ASC 842, operating leases are required to be on the balance sheet. This is the glaring difference between ASC 840 and ASC 842.
Consequently, many businesses looked like they were doing better on paper than they were. Many companies have dozens of operating leases. Companies should move applicable operating leases onto the balance sheet. This shows a more authentic reflection of where they stand.
How will ASC 842 affect your team?
Undoubtedly, the move from ASC 840 to ASC 842 creates a heavy lift for your financial department. Finance team members are responsible for finding, organizing, and abstracting lease-related contracts.
In addition, most accounting experts recommend engaging representatives from other departments to ensure proper documentation of all leases to maintain ASC 842 compliance. Details from lease terms to discount rates. It’s not good enough to assume or estimate right-of-use assets or lease liabilities based on your current population of leases. Therefore, you may want to ask people from procurement, IT, and other silos to assist—the more time you put into planning, the less complex you’ll find your first audit process.
What to expect during an ASC 842 audit
Remember that whether your organization is undergoing an internal, external, or IRS-fueled audit, the annual practice serves as an objective evaluation of your financial processes. If you create great processes around ASC 842, your audits will ultimately be less challenging.
Your auditors expect sufficient evidence and documentation to validate figures, calculations, and other information during the audit. Therefore, have the lease documents, digital abstractions, and calculations readily available. This will help auditors determine whether you’ve correctly disclosed and classified your obligations. Auditors will also want to understand other aspects of your leases, such as the commencement date, lease term, and the discount rate selected.
You want your organization to have accurate calculations, disclosures, and schedules in place. If your company’s audit trail was already relatively airtight under ASC 840, your transition to FASB ASC 842 lease accounting standards should be much less jarring and more rewarding overall.
Inherent benefits to the FASB ASC 842 lease accounting update
It can seem like ASC 842 adds more work to your team’s plate than they had under ASC 840. However, the new lease accounting standards have their advantages. Foremost, ASC 842 provides a complete snapshot of your lease liabilities. This enables you to understand and unlock financial insights previously hidden in your footnotes.
The new standard encourages you to rethink and refresh your lease accounting processes. Rather than allowing those processes to become too labor-intensive, you may want to add new software to your tech stack. High-end leasing software built to keep you within compliance with ASC 842 will help you monitor your lease portfolio and discover efficiencies outside of simply creating old-school lease accounting-related journal entries.
With the right software in place, your team members can better forecast one of your most significant expense items, fostering better vendor and data management practices. In addition, all financial statement users will come to appreciate the insight ASC 842 brings.
Want to know the final advantage of ASC 842? You’ll always be aware of your business’s most accurate financial position and better understand future obligations. That’s a huge bonus to you as a leader because it keeps you in a position of knowledge.
Who should own the responsibility of managing ASC 842 changes?
As mentioned, the people who make up your finance team will undoubtedly lead the charge when applying the ASC 842 transition. Yet the scope of work should include numerous teams and those in finance.
Depending upon the makeup of your organization, you may want to tap the insights of employees and partners — in real estate, facilities, human resources, operations, IT, and even the C-suite and boardroom.
Of course, it’s worth mentioning that you’ll want your internal and, if applicable, external auditor to come along for every step of the ASC 842 transition. Your auditor will help you stay aligned during the tremendous due diligence process required to move and enhance your auditing procedures from ASC 840 to ASC 842 levels and expectations.
Will everyone on your team know how to dedicate themselves to this process in the most streamlined and efficient way? Not necessarily. Consequently, you should prepare to assist everyone in understanding the importance and scope of their roles. Project management and leasing software can smooth the transition and centralize all information and discussions.
Investing in the most appropriate software for your organization will pay off because everyone will remain in close coordination. This is especially important during your first few 2022 post-transition audits.
Tips on gathering information needed for your upcoming ASC 842 audits
Even if you embark on a full-scale ASC 842 training program for your team members, they may still feel unsure about what they need for audits. Instead of simply assuming they’ll understand how to update their lease portfolio listings to promote compliance with ASC 842, set aside time to map the process.
You may want to consider building frameworks to identify critical points of contact, determine where and how to lease data will be housed, hand out specific departmental or individual responsibilities, and outline ways to measure lease liabilities and assets.
Some good questions to ask during this process include: “Who can give our auditing prep team members a list of recurring lease payments?” and “Where will our company house vendor contracts representing operating leases, and who need access to those documents?” The time you put into creating workflows and internal structures to support the new lease accounting standards will pay off big-time down the road.
More areas for consideration when guiding your ASC 842 transition methods
Eager to amass more insider tips to construct your business’s ASC 842 transition methods? Below are some areas you and your ASC 842 steering committee players will want to consider as you implement and enhance your audit procedures.
1. Data quality and data centralization
It’s no exaggeration to say that a single company may have thousands or tens of thousands of operating leases depending upon its size and sector. In the case of your business, you may have more leases than you realize. Therefore, the first and most crucial step in the ASC 842 transition planning process is ensuring that all lease data is abstracted accurately and stored in a centralized system for stakeholders to access and retrieve. After all, some of your stakeholders may be working remotely. Leveraging cloud-based software can simplify the process as well.
Regarding data quality, you’ll need to note that some leases — like embedded leases that convey the right to control an asset — aren’t apparent. One example of an embedded lease could be the right to use assets as a server. It could be overlooked if the right to use language is hidden within a more significant IT contract. Knowing this, empower your team to review all contracts to ensure you create a complete population of leases. You can mitigate data loss or over-extraction risks when you have your population by leaning upon your lease accounting software.
2. Validation of lease assumptions
Lessors and lessees make numerous assumptions when recognizing leases on their balance sheets. Your ASC 842 committee’s role is to organize and document your considerations of these assumptions. Doing so will help your auditors get through the assumptions.
Don’t forget that assumptions can and will change over time. An assumption that was valid when a lease commenced may no longer hold valid after some time. And even if a lease has not been modified, the assumptions may have changed. If you aren’t considering that, you could end up with a flawed balance sheet. Auditors won’t be pleased if they find out that your company hasn’t completed a review of your assumptions and made all remeasurements before presenting them with your ASC 842-compliant information.
3. SOC 1 Type II-compliant software
Maybe you already have a lease accounting software program in place. That’s fine, as long as it’s backed by SOC 1 Type II compliance instead of SOC 1 Type I compliance. So what’s the difference between the two, and why does this matter? At the most basic level, SOC 1 Type II reduces the need for stress testing by your finance team and auditors.
Indeed, both SOC 1 Type I and II report on controls and processes. However, the Type II report takes a broader look at your attestation of controls over at least six months. Additionally, Type II attests that all the controls are effective, appropriately designed, and properly implemented.
4. Audit procedures
Auditors are entirely reliant on your organization’s systems for their audit evidence. This puts the onus squarely on you to make it easy for them to understand how your organization records entry balances under ASC 842. In addition, ensure they can also determine whether you’ve put sufficient processes in place for examining future contracts.
Worried that you’re not laying out your documentation and evidence in a way that will appeal to internal or external auditors? Then, immediately involve any internal auditing staff members in the ASC 842 implementation journey.
Embracing FASB ASC 842 for the future of your company
Any operational change can initially seem tricky for your company and its employees. Nevertheless, the move from ASC 840 to ASC 842 doesn’t have to be stressful. Instead, consider it an opportunity to improve your lease accounting compliance protocols and standards. In addition, every audit is a chance to get a more detailed look at how well your business is meeting its financial goals.