The 5 steps all retailers must now take with their leases

It's official: ASC 842’s implementation is here.

This change has brought an estimated $3 trillion onto organizational balance sheets. Nearly every business can expect to be affected. Every contract across retail organizations will need to be analyzed — real estate leases, equipment leases, vehicle leases, and embedded contracts. Understanding what ASC 842 is and how it has changed companies’ accounting needs is fundamental to understanding how to address the challenges it poses.

The Financial Standards Accounting Board (or FASB) enacted ASC 842 to create rigorous reviews of companies’ financial health. One of its central requirements demands that companies report all leases on their balance sheets. This is no small task; dealing with more leases to report, given that operating leases cannot sit in the footnotes, and identifying which contracts have embedded leases. These two seemingly simple areas are more difficult to administer than they appear.

First, ASC 840 only required finance leases to be reported on company balance sheets. However, ASC 842 requires companies to record operating leases and financing leases. This change requires a thorough review of all current and future contracts to meet lease and lease liability reporting standards. Accounting teams and business leaders should be aware of the complexity of identifying certain items.

Second, outside of the sharp increase in leases and lease liabilities to record, is calculating your amortization schedules to build your monthly journal entries. Lease amortization is paying down a leased asset over a specified period of time. However, there are hidden problems, such as embedded leases.

Under ASC 842, there is a duty to look at each contract to determine whether it’s a lease. It is easier for someone with an accounting or legal background to appreciate this nuance. This review is challenging because the lease might not explicitly define itself as a lease, and the contract’s substance governs the analysis. Retailers must create and continue to refine programs to proactively meet their lease compliance needs and look for hidden issues.

Here are the five steps all retailers now take in their lease considerations:

1. Find and organize all retail leases

Sometimes the most foundational points are the best. Most tenants starting their ASC 842 journey do not have centralized lease storage and lease management system. Ultimately, fragmented data across multiple asset management systems and spreadsheets can cause the lease accounting audit to fail. Retailers must find their leases and cross-reference financial records to ensure they have properly addressed every lease and embedded contract.

2. Develop lease accounting policies

Developing lease accounting policies early in the lease compliance accounting process helps direct the long-term journey. Answer questions such as “Which practical expedients should we elect?”; “What is our incremental borrowing rate?”; and “How will we present our lease liabilities and right-of-use assets in our financial statements?” These lease accounting policy decisions will set teams up for a smooth compliance program.

3. Abstract and organize the retail leases

The heavy lifting involves finding all company leases, understanding ASC 842’s nuances, and finalizing lease policies. From there, it’s necessary to ensure all critical information is reliably and easily accessible. The lease life cycle involves numerous stakeholders from real estate, operations, construction, human resources, accounting, finance, and the C-suite. So a single source of truth is necessary for collaboration and to avoid costly errors.

4. Build sustainable processes

ASC 842 increases a lessee’s administrative burden due to the required increase in process control: data collection, analysis, maintenance, monitoring, internal reporting systems, and, most importantly, audit scrutiny. Retailers must build cross-department implementation teams to support the lease accounting transition. Beyond involving cross-department functionalities, it is critical to document the decisions and process details so that they are repeatable for future employees and available for audit review.

5. Leverage tenant-focused leasing software.

Consider whether software is right for the business. Generally, organizations with more than 10 leases should implement tenant-focused software. Many retail businesses haven’t used lease management systems because they haven’t had the need. ASC 842 changes that. Lease software should power the entire lease life cycle, from signing a new lease agreement to managing critical dates and complying with the new lease accounting standards.

Creating a solid ASC 842 compliance program will ensure future success. Businesses will receive scrutiny for their policy decisions related to ASC 842. Preparing for the compliance process early, organizing all materials, and documenting decisions persistently and precisely will greatly ease the pain of transition and set retailers up for lease accounting success.