The new Financial Accounting Standards Board rental accounting standard, ASC 842, entered into force for public transport and logistics companies last year. The FASB recently proposed to extend the deadline for closed companies to annual periods beginning after December 15, 2020 by one year, which as of August 2019 was still undecided. The new rules replace ASC 840, which has been in use for over 40 years, and change the way companies must account for financing (capital) and operating leases, shifting almost all leases to the balance sheet of the company.
Previously, operating leases could be reported as a footnote in the company’s financial statements, with no impact on the balance sheet. These new reporting requirements are a fundamental change in the way businesses must now account for their lease obligations and can have a significant impact on lease-versus-buy decisions as well as the company’s financial statements. Even for public companies that have passed the first year of compliance, many still struggle to develop repeatable processes to ensure continued compliance.
Transportation and logistics companies face significant challenges for ASC 842 adoption and compliance, due to the extensive and diverse types of rental assets that are at the heart of the business. Everything from vehicle and equipment rentals to leased storage units, planes and ships will be affected by the change. According to the International Accounting Standards Board, companies are expected to record up to $ 3 trillion in operating leases in their financial statements because of the new accounting rules. Companies with a large number of operating leases, such as logistics companies that lease planes, cars and ships, will be particularly affected. Highlighting the enormity, four of the largest publicly traded logistics companies alone moved nearly $ 5.2 billion in leases into their balance sheets as a result of ASC 842.
To further complicate matters, a slightly modified definition of a lease. Under ASC 842, “[a]contract is or contains a lease if the contract confers the right to control the use of an identified tangible capital asset (an identified asset) for a period of time in exchange for consideration. Compliance will require a change in mindset about what constitutes a lease.
Given these new requirements, transport and logistics companies will experience:
- Changes in accounting policy and practices. Most transportation and logistics companies will need to review and update their accounting policies and practices to align with the new standard. Equally likely, they will also need to perform additional analysis to determine how to apply the standards to certain leases.
- An increase in the assets and liabilities of the balance sheet. ASC 842 requires that operating and finance leases be capitalized on the balance sheet. The only exception is certain short-term leases of 12 months or less. Right of use assets (ROU) will be recognized in the balance sheet with a corresponding liability.
- The income statement changes. The new rules generally result in a linear expense profile for operating leases and an advance profile for finance leases. Interest and amortization charges will be presented separately in the income statement for finance leases, while the two are combined and presented on a single line for operating leases.
- Responsibilities of the tenant / lessor. Transport and logistics companies are in the unique position of potentially being both lessee and lessor. Careful review of the terms of the contract will be necessary to assess whether or not the agreement is a rental agreement and to identify the financial reporting requirements necessary for each rental agreement. Agreements can also contain rental and non-rental elements that require different accounting applications.
- Sale-leaseback modifications. There have been changes to what qualifies as a sale-leaseback transaction. Under the new rules, a purchase occurs when: (1) there is a contract and control has been transferred in accordance with the guidelines of the new revenue recognition standard (ASC 606), (2) the sale-leaseback does not is not a finance lease, and (3) a call option, if any, can be exercised at the asset’s fair value, and another substantially similar asset is readily available in the market. In this case, lessees must derecognize the asset and record a gain or loss on sales, if applicable. If no sale takes place, lessees do not need to derecognize the asset and should treat the transaction as a loan. Donors should reflect their cash payments as loans.
Although private companies were not required to comply with the new standards until annual periods beginning after December 15, 2020, public companies were required to start complying for annual periods beginning after December 15, 2018. Their experiences give companies private insight into the challenges. of compliance. One of the main lessons learned so far has been the tendency to underestimate the time required to successfully transition to the new standards. Transportation and logistics companies need to give themselves enough time to develop new lease reporting methods, policies and practices so that they do not miss a lease. Collecting and organizing this data takes time and accuracy is essential.
Based on the experiences of companies that have already switched to ASC 842, the transition can be facilitated by adopting some good practices:
- Develop a comprehensive transition plan. Companies that developed an action plan for the transition fared better than those that did not. Involve the finance and accounting teams, business leaders and managers who oversee the leases in the development of the plan, in order to accurately assess current and future rental obligations.
- Anticipate and assess complexities. The ASC 842 transition in itself is fraught with complexity. Once the additional complexities of transportation and logistics leases are added, the situation becomes even more difficult. Start the transition early and take advantage of the convenient expedients available to achieve compliance faster.
- Avoid common stumbling blocks. Some of the more common stumbling blocks include identifying embedded leases, determining differential borrowing rates, and sale-leasebacks. Plan to spend a significant amount of administrative time identifying built-in leases, differential borrowing rates for all leases, and the accuracy of sale-leaseback transactions.
- Invest in new “accounting first” systems that can grow with you as your business grows. Early adopters of public transport and logistics companies reported outdated or totally flawed technology as a huge lease accounting compliance issue, introducing financial statement risk. In fact, errors in the software were one of the main reasons why the The AICPA urged the FASB to extend the ASC 842 deadline for private companies.
One of the reasons these mistakes are made is the lack of a “bookkeeping first” approach. Most of the existing leasing systems claiming to handle the new lease accounting standards are lease administration systems that quickly added accounting capabilities to sell more software. Businesses have problems with the systems because they weren’t designed as systems focused on bookkeeping. Look for rental accounting software solutions designed by reputable accounting and tax software providers who have accounting and tax experts on their staff.
ASC 842 is here to stay. While accounting changes are the most obvious impact for transportation and logistics companies, they are not the only impact. The entire industry will need to learn a new way of doing business as the changes will impact budgeting, contract negotiations, financial statements, internal processes and controls, systems, data collection and reports. This is an opportunity to reshape and improve the functioning of transport and logistics companies for a more streamlined, precise and efficient lease management and continued success.
Adam Schrom is Senior Director at Bloomberg Tax and Accounting.