If you’re a CFO backed by private equity (PE), you’ve spent the past few years thinking (perhaps obsessing) about real estate. After the pandemic ushered in a new era of remote working, all the money organizations spent on real estate and office space became questionable.

More than two years into the pandemic, questions about real estate persist. Are you staying remote and making office space less essential? become hybrid and allow for a smaller and less expensive footprint; or use the impending recession as a way to shift power dynamics and get employees back into the office more permanently?

But if the “what” and “where” of real estate give headaches to CFOs of private corporations and other private corporations, then the “how” of accounting for real estate and other rental assets is what causes headache.

Alex Bogopolski

As all stakeholders know, the Financial Accounting Standards Board (FASB) has adopted the new lease accounting standard ASC Topic 842. The previous accounting standard (ASC 840) only required capital leases to be included on the balance sheet. The new rule requires most off-balance sheet leases to be registered. This nuance has huge implications for the CFO in terms of changing the way accounting is done for operating leases. The new approach could significantly change the balance sheet structure and the debt ratio (liabilities to equity), as well as have a negative impact on net working capital.

Is this new? No, the FASB adopted the rule in 2016, but delayed the effective date for private companies due to implementation challenges and the pandemic. However, it is now effective for annual periods from January 1, 2022. The problem is that too many private companies have looked into their other real estate problems (see above) and have not yet had time to ensure compliance with the near-deadline of the term. As a result, any business using outdated accounting entries for interim reporting (whether monthly or quarterly) will now have to convert the entire 2022 financial year, which is no small feat.

What does this mean for a CFO who is not already well along in this process, especially in industries such as consumer products, retail, distribution/wholesale, transportation, hotels and business services? They have to deal with it now.

Of course, the early bird doesn’t always catch the worm. If there’s a silver lining for latecomers, it’s that they can apply some of the lessons learned from companies that were first to comply with the new rule.

6 Commonly Overlooked Compliance Pitfalls

  1. The hybrid causes headaches. Many companies have revisited their vision of real estate, moving from large offices to remote or hybrid options. Likewise, retailers may have moved from brick and mortar to a more online presence. Either scenario can trigger complicated asset impairment testing and loss recognition issues.

  2. Treat terms with tact. Favorable or unfavorable lease terms previously recognized under prior regulatory guidance may no longer be recognized, such as deferred and accrued rent, unamortized initial direct costs or tenant allowances. In such cases, amounts recognized under ASC 840 should be reset to zero upon transition to ASC 842, either by being included in the right-of-use assets or fairness.

  3. Pay attention to the construction. ASC 842 significantly changes the way tenants assess their involvement in asset construction and bespoke transactions. CFOs attempting to account for such situations must be careful to determine who controls the underlying asset.

  4. Ask what is admissible. Many contracts do not have the name “lease agreements” in their title or were previously considered “service contracts”, such as the use of photocopiers, storage space or coffee machines. But these contracts can now qualify as leases under the new guidance and require corresponding recognition of the lease liability. It is critical that CFOs carefully review recurring monthly and/or quarterly payments to identify and account for these new lease assets.

  5. Examine expedients and exemptions. The new lease guidelines contain optional “expedients and exemptions” created to ease the burden of enactment and provide some measure of accounting relief. These tend to be related to ongoing transition and accounting, length of lease, public or private status of the business, etc. Although their proper use can be beneficial, they must be disclosed in the financial statements, which means that any misuse could prove problematic. It will take some expertise to ensure that these exemptions are more beneficial than burdensome in the long term.

  6. Complicated clauses. Added to all of the potential pitfalls above are the other complicated areas of analysis that cannot be overlooked when transitioning to new leasing guidelines. Some of the more nuanced issues relate to sale and leaseback, renewal options, leases acquired as part of a business combination, variable lease payments, foreign leases, non-leasehold items, lease amendments and monthly leases.

Now that the late bird has flown the worm, or at least is aware of the lessons learned, he’s ready to embark on real-life compliance implementation, using this six-step cheat sheet.

6 Steps to Implementing ASC 842

  1. To start up. An ASC 842 implementation project should begin with a kick-off meeting with all relevant financial and non-financial stakeholders to define and discuss the project scope, milestones, timeline, and definition of success.

  2. Analysis. Identify the lease population to ensure project scope completeness, then perform analyzes of current information and lease accounting processes. Identify technical accounting deficiencies and complete an issue log. Then perform a disclosure gap analysis, as ASC 842 has new expanded disclosure requirements.

  3. Data gathering. We know from practical experience that data collection can be a significant challenge, given the demands of this step. You should review the leases, extract all the information needed for the calculations, and select the appropriate discount rate – either a risk-free rate as allowed for private companies, or an additional borrowing rate if the company plans to go public in the future. Begin calculating amortization schedules and journal entries.

  4. Technological transition. It is essential that companies undertaking this initial adoption transition move away from Excel, which is prone to human error, especially given the amount of manual input, towards specialized Excel applications or modules. accounting for leases. Many of these modules only require you to enter entries into the pre-determined fields after the transition methodology and lease classification have been determined, allowing the rest to be performed automatically – calculations, transition journal entries and recurring monthly, and disclosure of lease footnotes. It is important to select the most appropriate technology platform and specific software package considering the size of the business, demand for scalability and future growth, implementation/maintenance costs, as well as user-friendliness and ease of use of the application interface.

  5. Implementation and project management. The CFO of the private company must create strong lease implementation project management, whether an internal resource or an external expert, that takes into account the perspective and needs of the company. informing all stakeholders: sponsors, board and management, creditors/lenders, business units and reporting and budgeting.

  6. Create end-state deliverables. Typical end state deliverables should include ASC 842 Transitional Accounting Memorandum, a new formalized lease accounting policy, a new lease checklist, and a lease workbook containing amortization schedules and accounting entries. monthly journal for each simple and financial rental.

We’re not going to lie; if you have not completed your 842 transition, you have moved from the 411 Information Gathering category to the Emergency 911 category. The good news is that other people who have already walked this path have provided a roadmap of some of the most common pitfalls. The experts can also provide step-by-step checklists to help CFOs undertake this initiative more programmatically, alone or with the help of these experts, given the now accelerated compliance timeline and the nuances of the new rules. .

Alex Bogopolsky is a Principal at Accordion, the private equity-focused financial advisory and technology firm.