Understanding how and when to start the transition of your business's leases from ASC 840 to ASC 842 can be difficult to determine. Especially since there were Financial Accounting Standards Board (FASB) rumors of an additional deferral for private companies even after its first deferral. On November 10, 2021, the FASB had further clarification and announced there will be no deferral for private companies and the concerns of those in favor of the deferral had many of the same concerns as the previous initial deferral.
“Topic 842 becomes effective for private companies and not-for-profit organizations that are not conduit bond obligors for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022.
“Some private companies and not-for-profit organizations have already adopted Topic 842. Entities that have not yet adopted Topic 842 as of November 11, 2021, are required to adopt the amendments in this Update at the same time that they adopt Topic 842.”
Although the FASB did not delay the standard for another year or two, they issued additional guidance on November 11, 2021. The improved guidance in determining a discount rate for non-public lessees is to address difficulty in determining the incremental borrowing rate and the option to elect and use the risk-free rate by class of underlying asset rather than at the entity-wide level.
Now that we know there will no longer be a chance of deferral at the end of the year, you will need to start thinking of how you will account for your leases by 1/1/2022. To start you will need to remove any balance you may have in deferred rent and calculate both the ROU (Right of Use) asset and liability.
With all these new considerations, the best time to start working on how to attack the new standard is now.
STEP 1 – Kickoff Team:
Your first step is assessing who will work on this project and outlining a timeline for completion. Depending on how many leases you have, your team could be just one person or a large group if you have hundreds of leases.
STEP 2 - Collect Leases:
Collect a complete list of leases contracts, lease schedules, payment schedules, along with any amendments or modifications that happened during the life of the lease.
First, tie-out the lease population to your deferred rent balance to help provide comfort over the completeness and accuracy of your lease population.
Second, once you are comfortable with your lease population use guidance from accounting firms to build out your lease schedule and determine your lease payment and expense, adjustments to ROU Asset and liability, and your Incremental Borrowing Rate.
Third, calculate your Lease Liability based on Net Present Value of the Lease payments over the life of the lease and your ROU Asset should be the same as long as the lease has no indirect costs, prepaid lease payments, and lease incentives.
Fourth, if you have deferred rent, use a manual entry to remove your deferred rent balance and establish a new balance sheet account that will be the difference between your ROU Asset and Liability The difference will be dependent on your indirect costs, prepaid lease payments, and lease incentives. This balance will be amortized over the life of the lease through lease expense.
Fifth, use your schedules to help you make journal entries for each lease monthly/quarterly depending on your process.
Calculating is the ROU asset and liability is easy if you have a plain “vanilla” lease. However, since the COVID-19 pandemic, over the last two years many leases have been modified to accommodate changes in office space needs. Early termination, renewals, fluctuating payments, ROU Impairments and many other types of modifications can be incredibly tedious to track if everything is in an Excel spreadsheet. Now compound that complexity by adding modifications during the lease period.
STEP 3 – Select Software:
Manually using spreadsheets will make this an incredibly tedious process every month, especially if there are any modifications during the lease's life. Get a software solution that works with your ERP. A stand-alone solution will still require work to export and import data into your ERP. An embedded solution will work seamlessly with your platform.
Using Netgain’s product NetLease will make leases easy and automated. We take care of the calculations for each of your leases with all the scenarios you are thinking of including prepaid rent, lease incentives, initial direct cost and various IBRs. We make managing those leases easy with automated journal entries at the end of the month, available individual or mass modifications and a breakout between your lease and non-lease payments within your schedules. NetLease makes the accounting side incredibly easy for your accountants so they can focus their time on their individual expertise.