A season of ASC 842 adoption - lessons learned

By Josh Elder, CPA, and Ara Grigorian, CPA, CCIFP

The January 2022 effective date of the lease standard impacted many of the non-public company audits as of the Dec. 31, 2022, reporting period. After a spring season of working through the nuances, it made sense to give some perspective on what to consider as we work through the next wave of adoption for fiscal year ends as well as looking forward to year two this spring. This is not a complete guide to this expansive standard, which in fact was a significant change to the lease and the balance sheet landscape. The following is organized into the top five lessons learned during adoption, matters for consideration in year two, along with alternative approaches to adoption.    

1. Completeness – This sounds simple for the auditors out there…did we get everything? When you think about the processes of your client adopting or the preparer establishing a completeness process, there should be more meat than just checking a box or answering a series of questions. In the most successful engagements, the preparers spent some time refreshing their authority understanding within their company. Meaning who can initiate and obligate the company in a lease contract. Finding the breaks in the process chain as well as what to look for when doing the review of monthly payments (recurring cash flow) is a great way to speed up and make your completeness review more meaningful.
2. Estimates – There are several estimates when at lease commencement. A significant estimate includes determining the incremental borrowing rate when an implied interest rate is not provided in the lease contract. Considerations include the type of asset leased. The estimated incremental borrowing rate should be tied to similar collateral. Selecting a line of credit rate secured by real estate may not be consistent with a financing rate for heavy equipment. Timing is also a consideration as the rate is established at lease commencement, which during adoption means we are considering conditions at a historical date. Most lease contracts include renewal options and buyout options. These options must meet the reasonably certain to renew or exercise buyout option thresholds established within the standard This determination extends the term on renewal options and lease classification. Finally, if you have determined the lease renewal option will be exercised, the length of the term would need to be considered.  Related party leases may need to be evaluated for actual lease term as they tend to be silent and implied forever leases. The best approach is understanding the asset and how it fits into the current needs and strategy of the company. 
3. Nuance – There are several additional considerations when reading through lease agreements from lease incentives and tenant improvement allowances to complex common area maintenance arrangements. Each lease really can have its own identity. A preparer should take the time to read and understand before creating the right-of-use asset and amortization schedule for your lease liability. Auditors should consider the risk profile and, of course, materiality within the audit when selecting leases for testing and review. These factors directly impact the value and can lead to remeasurement considerations in year two and three of the lease.
4. Disclosure and presentation – Accounting aside, reporting can be equally challenging to get the number necessary to meet ASC 842’s disclosure requirements. The adoption disclosures typically can be less challenging to the accumulation and support for the weighted average and future maturity schedules required. Statement of cash flow presentation could significantly vary based on the discussion previously of the nuance on the lease activity during the year. Leveraging a tool, which is the final lesson learned can save time and limit exposure to incomplete information being presented within the report.
5. Technology and tools – There really are benefits to embracing this new standard through the utilization of a lease software or tool. The opportunity cost likely rests with the amount and frequency of leases within the financing strategy of the company as well as the complexity of the underlying leases. There are several solutions available that are scaled for the needs of the company—ranging from simple one-time fees to subscription-based fees with the ability to integrate with other software and platforms. Building a sound process is further strengthened by utilizing an electronic solution.

Year Two

The biggest consideration for year two is understanding the estimates established for reasonably certain to renew and purchase options. Have there been changes to consider like ASC 360-10-35-21 long-lived asset recoverability considerations; significant decrease in market price; significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition; or a significant adverse change in legal factors or in the business climate that could affect the value of the long-lived asset? Forecast adjustments to the strategy of the company may lead to assumptions no longer being supported on lease commencement estimates such as lease terms, renewal and buyout options. Next, the auditors will need to consider testing approach post-adoption. Like property, plant and equipment, has the preparer established a solid roll-forward process and are there new material leases? To the previous discussion, what is the frequency estimate review or circumstances established by policy to review existing leases for change in estimate?

Alternatives - Pick on someone your own size

Burying your head in the sand to avoid implementing new accounting standards doesn’t work. The knee jerk reaction to avoid implementing a new standard may resort to overhauling the accounting framework to cash, tax or modified accrual basis of accounting. Many times, the users of the financial statements require more information than these special purpose frameworks provide. This does vary based on the intended use of the financial statements. For example, most sureties will not accept anything less than Generally Accepted Accounting Principles (GAAP). Consideration for GAAP departures within the auditor and accountant’s review reports offer some flexibility in the implementation of new standards, but you can accumulate multiple departures overtime and have a three-to-four-page report accompanying your financial statements! Fortunately, there is relief for many financial statement preparers.

The Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMSEs) offers financial statement preparers an opportunity to turn the clock back to a time when disclosures didn't read like stereo instructions. The AICPA established this framework so a “CPA can prepare financial statements that clearly and concisely report what a business owns, what it owes and its cash flow.” It was established so lenders and others can clearly understand key measures of a business and its creditworthiness. Doesn’t sound like ASC-842 fits in this framework, does it? Fortunately, the lease standard, among other new standards, falls out of scope of the FRF for SMREs, which ultimately means less work for the preparer. There are no strict qualifications for what makes an entity small or medium sized, but it’s safe to say that most local businesses in Oklahoma would likely qualify.

With endless CPE, lease tracking software and hours of consulting services, it’s easy to get lost in implementation. The pursuit of any truth can leave us stranded, but we must ask ourselves if the journey is worth it. There have been numerous occasions when I’ve informed financial statement users about new accounting standards and received the same response of “as long as I’m getting accrual financials, we should be good.” Or to paraphrase, “I’m not interested in these new standards, just give me what I’m used to seeing.” This interpretation may sound harsh, but we must remember that not all users are alike , and therefore our approach as financial statement preparers should be flexible.

We encourage you to learn more about the FRF for SMSEs using the following link: https://www.aicpa-cima.com/resources/article/financial-reporting-framework-for-small-and-medium-size-entities

Josh Elder, CPA, has more than 10 years of experience providing assurances to both external clients and internally as part of an internal audit function. While in public accounting in a small firm, Josh worked on non-profit and privately held business in the manufacturing, retail, and fabrication fields, municipal and tribal governments, as well as employee benefit plans. He is a 2007 graduate of Southwestern Oklahoma State University and a member of the American Institute of Certified Public Accountants and the Oklahoma Society of Certified Public Accountants. Josh was named a 2017 OSCPA Trailblazer and was selected to attend the AICPA Leadership Academy in 2018.

Ara Grigorian, CPA, CCIFP, has 10 years of experience working in industry and public accounting. Ara has worked primarily for small CPA firms in Oklahoma City. He currently provides accounting and assurance services for the construction industry. When time permits, Ara enjoys publishing accounting lessons related to the construction industry. He is a member of the Oklahoma Society of Certified Public Accountants and serves on the Careers Committee. He is also a member of the Construction Financial Management Association.