After a failed attempt to secure another deadline extension, 2022 is—for real—the year private companies have to tally up all the real estate, equipment, and vehicles they rent and report them on their balance sheets for the first time ever.
By all accounts, figuring out how to comply with the Financial Accounting Standards Board’s new lease accounting standard will be a major undertaking. Luckily, private companies don’t have to comply as soon as the calendar turns to January. Private businesses have until their first annual report of 2022, which for most calendar-year companies will be Dec. 31, 2022.
“They’ve got the year, but they shouldn’t squander that,” Booth said. “It is a big project to go through and identify all the leases.”
The first hurdle: tracking down all leases to figure out how to measure those liabilities. Sounds simple, but it’s not.
Under the new standard, ASC 842, a lease is “a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment” for a period of time in exchange for money. With this updated definition, there could be leases lurking where companies don’t expect them—and they must be reported.
Hunting for Leases
Fast food chain Chick-Fil-A Inc. found this out firsthand when it started gearing up to follow the new rules. The privately operated chain had to scour supply chain agreements and service contracts to see if any met the definition of a lease and therefore had to be reported on its balance sheet, said Douglas Uhl, principal team leader, corporate accounting policy, at the company.
“We have processes in place to capture leases that say ‘leases’ on the top, but we have a very decentralized procurement function, just like many companies do,” Uhl said in a December meeting with FASB’s private company and small business advisory panels.
Most companies’ finance teams can readily identify big-ticket real estate leases, but smaller contracts for equipment or vehicles may be harder to track down. The details of those agreements may be in the hands of other parts of the business, such as operations. Then there’s the challenge of identifying the leases’ inside service contracts, like figuring out whether a two-year agreement to service a line of rented photocopiers counts as a lease.
FASB published the leases standard in 2016 after years of debate about the best ways to shine light on the money tied up in contracts to rent everything from factories to forklifts. For decades, companies reported lease obligations on their balance sheets only if the leases were akin to financing arrangements.
Outgoing lease rules contained so-called “bright lines” that let companies structure their contracts so they rarely had to report them. A company that took out mortgages for office space factories or financed the purchase of airplanes looked more indebted than a company that had big payments due every month for leases, investors and analysts complained.
Public companies had to follow the new lease accounting rules in 2019. They added billions in new liabilities to their books. Private companies and not-for-profit organizations were supposed to comply in 2020, but FASB in late 2019 extended the deadline for an extra year.
While private companies can benefit from the lessons public companies learned in adopting the rules, they still will face some challenges, especially the continuing fallout from the pandemic.
In addition to dealing with labor shortages and potentially burnt-out employees, the pandemic has forced businesses to tweak their leases. Some companies embraced remote work and shrank their real estate footprints, which could add some lease accounting headaches as they figure out how to account for modified or canceled leases.
The pandemic has also changed how some businesses operate. For example, supermarket chains adapted to home delivery and drive-up orders. Many supermarkets had to rent large, separate freezers and fridges to store those orders. The new equipment will need to be tallied and accounted for if it is material to the bottom line, said Booth, of LeaseQuery.
“There were so many real estate changes, so many distribution changes—all those have pretty significant accounting impacts,” she said.