The majority of private companies have yet to implement the new lease accounting standard entirely, even though the effective date is fast approaching.
Three-quarters (75%) of privately held companies
The respondents cited a number of reasons why they haven’t implemented the new standard, noting the process was delayed by the pandemic (43%); it was taking more time than expected (42%); they didn’t have all the necessary lease data gathered (41%); they were still learning about the requirements (39%); they didn’t have required people, resources and technology in place (36%); and it was a low priority (21%).
“Private companies are, among other things, less resourced,” said Joe Fitzgerald, senior vice president of lease market strategy at Visual Lease, and a former lease accounting technology leader at Ernst & Young. “Large public companies tended to have someone who maybe was just focused on new accounting pronouncements. A lot of private companies don’t have that role, so the folks in the controller shop typically have to figure out how to get this done, along with everything else. Unlike public companies, private companies don’t really have quarterly reporting requirements, so they’re thinking that this is maybe an end of year 2022 exercise, not recognizing that they’ve actually got to have a journal entry to book as of the first day of their reporting year, which for a lot of companies is Jan. 1, 2022.”
Even with the delays, many private companies have been waiting until the last minute to get the standard implemented. “This is a standard that has been delayed so much for private companies because of the lack of preparedness by private companies, and then COVID essentially allowed for another year’s extension,” said Chandu Chilakapati, a managing director at consulting firm Alvarez & Marsal’s valuation services practice. “What we’re seeing is that private companies are still a little slow to invest in preparedness. From where we sit, we tend to see companies that need assistance with estimating the incremental borrowing rate. We’ve seen a pretty large pickup in terms of companies needing that assistance. They started around June or July. That is telling us there’s a number of companies that at least started that process and started to evaluate how they’re going to get that incremental borrowing rate, which is required to record the value of their right-of-use assets and lease liabilities appropriately.”
Private companies that plan to go public through an initial public offering or a special-purpose acquisition company have also needed to go back and determine their lease accounting for the past three years under the new standard.
“We saw a lot of increase due to SPAC activity, which required a number of private companies to implement it earlier because they would have to go back for the three-year period and show as if they were a public company for the prior three years,” said Chilakapati. “That caused a big uptick in implementations. In general, people have seen the public companies go through this and are a little better aware of how to handle it themselves.”
Among the challenges cited by the survey respondents were adopting new technologies into the process, facilitating interdepartmental collaboration and coordination, abstracting and validating data, accurately classifying leases, identifying all lease components and embedded leases, understanding the new requirements and educating staff, and developing new processes, policies and controls.
“Two out of five said they were less than confident about their ability to adopt ASC 842 in time for their company’s financial statements, which is concerning,” said Fitzgerald. “On the positive side, 100% of the folks responding say that they see some benefit to adopting the standard. They clearly recognize the benefit, but a large majority have yet to get going on it.”
Embedded leases, in which components within contracts involve the use of a specific asset, and the user has control over that asset. can be difficult to uncover in some cases. Many private companies have limited staff available to go through their contracts and identify what’s any embedded leases.
“They didn't really anticipate just how difficult certain aspects would be that aren’t necessarily accounting, but just gathering your leases, and being able to abstract the relevant data elements out of those lease contracts,” said Fitzgerald. “Some contracts will in effect be leases. They’re embedded leases. They don't even know what they have. Everybody’s got a day job, so they’re trying to fit this in along with everything else.”
Embedded leases seem to be even more of an issue for public companies. “We didn’t see as much of a concern over the embedded leases that we saw with the public companies, and it might be that private companies are a little bit smaller and didn’t enter into as many complex types of contracts,” said Chilakapati. “It’s also possible that they didn't run into those types of issues just because maybe they weren’t as thorough in terms of reviewing all their contracts. We didn't see as many large implementation projects as we did with the public companies. Maybe they learned in terms of what contracts to look at a little better from the public companies.”
He has also seen improvements in the lease accounting software over the years, which will also benefit private companies after public companies were the early adopters. “On the implementation side and the software associated with it, they had two years to get the bugs and kinks out, and so it seems like the software providers are also offering more resources and making it a little more efficient for private companies,” said Chilakapati.
While some companies have expressed the wish to FASB’s Private Company Council that they would like more time to implement the standard, that’s not likely to happen. “Private companies have had five or six years to get ready for this standard,” said Fitzgerald. “Another delay is just going to kick the can down the road for yet another year. When they did the prior delay for COVID, that was earlier in the year. Here we are now in October, two months before, and it seems almost a little late to pull the plug. A lot of companies have made progress, and 25% of the companies we surveyed say they are already compliant with standard. A lot of other companies are getting started, so you don’t want them to stop.”
Overall private companies seem to be making progress, but many of them may not actually fully implement the standard until early next year. “Private companies, just because of their size, are less likely to have as many leases,” said Chilakapati. “It seems like they’re handling it pretty well, but the big push will probably be at the beginning of the year. That’s when we'll probably see a mad scramble to implement.”
