Implement Topic 842, Leases : Lessons Learned and Steps to Ease Adoption

Summary provided by MaterialAccounting.com: This article provides an overview of ASC 842 and tips for the implementation process. 

Implementing the Financial Accounting Standards Board’s (FASB) Accounting Standard Codification® (ASC) Topic 842, Leases, has proven more challenging, time consuming, and resource-driven than many organizations anticipate. However, thanks to the FASB’s date extension, there’s still some time before the standard becomes effective.

In June 2020, the FASB delayed the effective date of Topic 842 for entities that hadn’t yet issued their financial statements—or made financial statements available for issuance—reflecting the adoption of Topic 842 as follows:

• Public not-for-profit entities. Fiscal years beginning after December 15, 2019. Public not-for-profit entities includes not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
• All other entities. Fiscal years beginning after December 15, 2021.

Entities should start the adoption process now if they haven’t yet done so. The good news is, they have the benefit of learning from public business entities and other early adopters.

Below are seven lessons learned from entities that already adopted the standard that may help ease the transition process.

1. Make a Formal Plan, Begin Early, and Consider Leveraging Assistance

Regardless of an entity’s size, adopting Topic 842 will require an investment of dedicated time and resources.

Taking the following steps can help your organization get a head start.

Assign Responsibilities and Make a Plan

As with any significant project, organizations can benefit from creating a task force, defining responsibilities, and making a road map, including:

• Clear steps and stages
• Deliverables for each stage
• Realistic timeline and target completion date

Putting the right team in place, breaking down implementation into manageable phases, and enacting the necessary operational processes and procedures for compliance is key to a successful transition.

Start Early

Allowing ample time for implementation will alleviate unnecessary stress and last-minute efforts.

A significant portion of key decisions and the implementation process can and should begin well in advance of financial close for the implementation period.

Outsource When Needed

Many organizations already stretch resources thin with normal operations, and a significant change in accounting policies can introduce an unmanageable time commitment. Organizations may consider the cost and benefit of outsourcing the process to alleviate the burden.

Even when outsourcing Topic 842 implementation, organizations should still expect to commit time to attend meetings, make decisions, and provide contracts and support to their consultants.

2. Decide on Practical Expedients, Key Definitions, and Accounting Policy Elections

Organizations need to make many decisions regarding how they adopt and apply Topic 842. The first is whether the new standards will be adopted as of the beginning of either:

• The period of adoption
• The earliest period presented in the comparative financial statements

Practical Expedients and Other Elections

Topic 842 provides several practical expedients and transition relief opportunities organizations will need to evaluate for potential election. Other decisions include:

• How to present right of use (ROU) assets and lease liabilities on the statement of financial position
• How to define and calculate the incremental borrowing rate
• If a de minimis threshold should be applied to scope out immaterial contracts from evaluation similar to a fixed-asset capitalization threshold

Definitions and Interpretations

The new lease standards are more concept-driven than the bright lines under extant lease standards.

With this in mind, organizations should discuss and define how they’ll apply conceptual terminology such as substantially all, major part, or reasonably certain. Existing accounting policies should be updated based on these decisions.

These formal and informal elections should be documented and approved following your organization’s policies and procedures.

3. Identify a Complete Population of Contracts for Evaluation, Including Embedded Leases

This is often one of the most overlooked and time-consuming steps in the process—even for organizations with few or no leases recorded under extant lease standards.

Topic 842 updates the definition of a lease to, “a contract, or part of a contract, that conveys the right to control the use of an identified asset for a period of time in exchange for consideration.”

As the new definition includes the phrase “part of a contract,” organizations must evaluate all contracts for potential “embedded leases.”

How to Identify and List Contracts

Organizations can get started by making a complete list of effective contracts for scoping and evaluation. This step can become complicated for organizations that don’t regularly maintain and update a complete inventory of effective contracts.

In this case, it may be helpful to begin with a listing of disbursements by vendor and evaluating vendors to identify any contracts that may be in place through the following process:

• Determine vendors. Identify all vendors used since implementation date.
• Establish which vendors require evaluation for potential leases. This scope may be determined based on the amount paid to vendors or the nature of vendor. For example, legal firms could be scoped out from evaluation based on minimal risk that contracts with these firms or contains a lease.
• Locate all contracts. For vendors requiring evaluation, identify a complete and accurate population of contracts. Consider looking at invoices to identify if contracts are referenced.
• Identify leases. Review contracts to determine which represent leases or contain embedded leases.

Not-for-profit entities should be aware of instances of donated rent or below-market rent as an indicator of an underlying lease to be considered. This population may be derived from vendor listings above as well as reports from development or facilities departments. These leases should be separately identified; there are special accounting requirements for recognition of donated rent and below-market leases.

This is a critical step that auditors will be interested in when testing the completeness of a lease population.

4. Consider Adopting New Software

One of the most important decisions an organization will face is whether to purchase new software to assist in lease accounting.

Several new software programs and tools have been developed to help organizations with lease evaluation and ongoing accounting. These can generate monthly journal entries, audit schedules, year-end financial statement disclosures, and more.

An organization’s decision to purchase new software may be influenced by its quantity and complexity of leases. While calculation for initial and subsequent accounting for leases can be performed within Microsoft Excel or other simple programs, these may be more susceptible to error and often require more thorough internal controls.

5. Update Internal Controls and Involve the Entire Organization

The impacts of Topic 842 extend beyond the initial implementation procedures and often require an organization update their internal control policies and procedures.

Organizations may need to implement new controls to identify and evaluate new and modified contracts and determine whether they’re a lease or contain a lease.

These controls often extend beyond the accounting department, so procurement or legal departments should be informed of the new guidance so that they can help with the process.

The new lease standards require organizations to apply additional judgment. To do this, they can update review controls to verify any judgments applied are reasonable and adequately documented and supported.

As new software is developed, the accounting department should work with IT to verify proper controls are implemented, including system development and security and access controls.

6. Consider Impact on Metrics, Reporting, and Compliance

Organizations should expect a change in their statement of financial position; Topic 842 implementation generally results in increased assets and liabilities.

For organizations that present a classified statement of financial position, current liabilities will generally increase without any impact to current assets because ROU assets are classified as noncurrent assets. This change may impact:

• Liquidity disclosures and considerations

• Financial covenants for debt
• Internal metrics, including those impacting bonuses
• Composite scores for higher education institutions

In certain cases, debt or other agreements may be unclear about whether lease assets and liabilities should be included in certain calculations.

To identify and resolve any confusion that may arise from adopting Topic 842, organizations should consider initiating conversations with lenders and regulators early in the adoption process.

7. Communicate with Your Auditors

Involving auditors early in the adoption process can help prevent surprises at the end of implementation. It will also allow them to provide observations during key phases of the implementation process as well as insight into any conclusions.

Auditors typically need additional time to review the initial implementation as well as subsequent accounting. When possible, shifting the timing of these procedures away from year-end fieldwork may help reduce stress and capacity constraints.

We’re Here to Help

For more details on lease accounting, see our Lease Accounting Guide. For help with your specific implementation efforts, contact your Moss Adams professional.