Lease accounting standard evolves in U.S. and abroad

Private companies in the U.S. are still adjusting to the lease accounting standard that took effect last year, even as international standard-setters are proposing new rules for the public sector.

In the U.S., the Financial Accounting Standards Board's ASC 842 lease accounting standard took effect for private companies last year after a delay due to the pandemic, although public companies started using it in 2019. FASB has been tweaking the standard a bit, proposing last November a change in the accounting guidance for leasing arrangements for entities under common control (see story).

During a meeting last month of FASB's Private Company Council, the PCC members seemed to support the proposed practical expedient, which would enable nonpublic entities to use written terms and conditions of an arrangement between entities under common control to determine whether a lease exists. Under the proposed update, according to a FASB report on the meeting, leasehold improvements associated with arrangements between entities under common control would be amortized by the lessee over the economic life of the leasehold improvements, as long as the lessee controls the use of the leased asset. 

Courtesy of GASB

After a long wait, private companies finally seem to be adopting the new lease accounting standard, which puts operating leases on the balance sheet for the first time at many companies. 

"It's important to remember that this initial deadline is for your financial statements for the year, so no one's missed a deadline yet," said Ane Ohm, CEO of LeaseCrunch, a provider of lease accounting software. "As a CPA myself, who has been responsible for financial statements in the past and adopting accounting standards, I can say what we're experiencing here is very normal."

She estimates that approximately 20% of private companies have already adopted the standard, but 80% have not for a variety of reasons. "By now, most people should be getting started, no matter what their fiscal year is," said Ohm. "This first year, they only have to do it for the full year end."

Visual Lease CEO Robert Michlewicz, whose company also develops lease accounting software, has likewise seen an increase in adoption in recent months by private companies. "Everybody has to be compliant by the end of 2022," he said. "We've seen a big uptick here, specifically in the second half of the year." 

Ohm saw a big increase in business in December, compared to November. That matched a similar increase when a similar standard for state and local governments, GASB 87, from FASB's sister organization, the Governmental Accounting Standards Board, took effect in June 2021 after a pandemic delay. But again, much of the adoption occurred the following year, and Ohm saw a huge increase in initial adoption last October. "That was four months after their fiscal year ended, and they were finally adopting the new standard," she said. 

Ohm believes January, February and March of this year will continue to be big adoption months for FASB's ASC 842 among companies with a December 31 year-end. 

FASB's proposal to change the standard for leases under common control will be helpful for some companies.

"It was really just a clarification and a good one to simplify things for companies," said Ohm. "Companies wanted to make sure that they were doing the right thing and didn't get themselves in trouble. As a result, I think they were taking the original language around leases to the nth degree and feeling like they had to get attorneys involved to approve the language for related-party transactions, if a company operates in a building that is owned by a separate group."

She pointed to the example of a parent who sells a business to a son or daughter, but retains the building ownership, and that rent is a form of income for the parent.

"It's a parent-child relationship," said Ohm. "They're not being real stringent on the agreement. People were interpreting the new lease standard as if they had to get attorneys involved and really tighten up the terms between them. That wasn't the intent, so the FASB just clarified that if you have written terms, those terms are binding. Those are the terms that you can use for applying the new lease standard. You don't need to get attorneys involved. That's a good thing."

"That's what I've seen consistently from the FASB," she added. "When questions come up, the response from the FASB is typically one that is simplifying the adoption, not complicating it further. You never know how somebody's going to interpret things, so when they see that people are interpreting things in a way that makes it harder, they seem to come out with guidance that walks that back."

Michlewicz is more cautious about the proposed changes. "I think it's to be determined," he said. "It all depends on where it's going to land."

But he is seeing greater adoption of the lease accounting standard among private companies. "Now that most companies are getting through their initial compliance requirements, they're really starting to focus more on the lease controls themselves," he said. "We're working with them quite a bit on making sure that their technologies are aligned to not only achieve sustainable compliance, but to really make sure that they're administering those lease controls that are aligning to their internal controls for financial reporting framework."

The rise in interest rates over the past year has been having a big impact on leasing versus buying real estate and other property.

"With the rise in interest rates and inflation, these are likely to result in higher incremental borrowing rates being determined for all new leases," said Michlewicz. "Companies are really starting to pay more attention to and resetting their incremental borrowing rates. Also, with the way that companies are trying to preserve cash, traditional lending is drying up, so it's causing them to move from purchasing of capex assets to leasing a bit more. We're specifically seeing this be a boom, especially on equipment leasing."

He cited a recent study from the Equipment Leasing and Finance Association showing a 5% increase in new business year to date in November 2022, compared to the same period in 2021.

"They expected it to grow from $1.1 trillion in 2020 to $1.8 trillion in 2025, and then $2.5 trillion by 2030," said Michlewicz. "That's pretty substantial. But there's also a pivot to moving from a capex of assets to leasing where they can, where you're seeing an increase in portfolios on the equipment side. And then there's been a rollercoaster effect starting to occur on residuals. There's really an uptick in sales leasebacks, as companies are trying to raise and have more access to cash."

Leasing abroad

Meanwhile, the International Public Sector Accounting Standards Board released an exposure draft Tuesday of a proposed standard on concessionary leases and right-of-use assets in-kind and amendments to an existing standard, IPSAS 23, "Revenue from Non-Exchange Transactions (Taxes and Transfers)."

The exposure draft came in response to an earlier request for information on concessionary leases and other arrangements similar to leases.

"In light of the responses to  the RFI, the IPSASB decided to propose new guidance on concessionary leases and right-of-use assets in-kind," said IPSASB Chair Ian Carruthers. "The proposals in ED 84 will provide new guidance that will enhance transparency, accountability, and decision-making in the public sector."

The exposure and related documents, including a feedback statement, at-a-glance summary and webcast are available here. The IPSASB is asking for feedback by May 17.