By now all organizations should have implemented Accounting Standards Codification 842, Leases (ASC 842), into their financial reporting practices under generally accepted accounting principles in the United States of America. The Financial Accounting Standards Board (FASB) introduced ASC 842 to address the longstanding concern of lease accounting transparency. ASC 842 aims to provide a comprehensive framework for reporting leases, mandating organizations to recognize right-of-use-assets (ROU assets) and lease liabilities on their balance sheets. While ASC 842 was introduced to enhance financial reporting accuracy and comparability, its adoption has proven to be a complex and challenging process for many businesses.
One of the primary challenges faced by organizations adopting ASC 842 is the complexity of implementation for new or existing leases. The standard requires organizations to reassess their lease portfolios, identify embedded leases, and calculate lease liabilities and ROU assets. This process demands a thorough review of existing or new lease contracts and an understanding of complex lease terms, which can be intimidating whether you are an organization with a large and diverse lease portfolio or an organization with only one lease. In most instances, each lease presents a unique challenge with implementing the provisions of ASC 842.
Specifically, determining the lease term has been a challenge for organizations. Part of the confusion is when to include renewal options as part of the lease term. ASC 842 indicates that if the organization is reasonably certain to exercise the renewal option, then the renewal option should be included as part of the lease term. In practice this has led to much subjectivity in interpreting the standard as various factors such as economic incentives or site-specific reasons are evaluated. Including renewal options as part of the lease term will increase the ROU assets and lease liabilities recorded by organizations. The lease term also has a significant impact on the classification of the lease as either operating or finance under ASC 842, which impacts the accounting treatment. In both instances, ROU assets and lease liabilities are recorded on the balance sheet, however differences arise for accounting in the income statement. Under operating leases an organization will record straight-line lease expense in the income statement, whereas under finance leases an organization will record straight-line amortization and interest expense.
ASC 842 also requires changes in financial reporting processes. Lease contracts must be reassessed whenever significant modifications occur, leading to continuous monitoring of lease agreements to ensure accuracy and consistency in financial reporting. Maintaining compliance with the standard’s requirements for reporting, disclosures, and the tracking of lease modifications adds to the administrative burden and requires a robust system to ensure accurate and timely reporting.
The adoption of ASC 842 has and will continue to have a significant impact on organizations’ financial reporting processes. Many organizations have struggled with implementing ASC 842 based on the complexities of the standard. If your organization is experiencing difficulties with the implementation of the standard or the ongoing monitoring required related to changes for contract modifications, we would welcome the opportunity to discuss your specific needs and how our services can facilitate a seamless ASC 842 implementation process. Please feel free to contact one of our specialists to schedule a consultation or to inquire about our services.
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