Understanding Leases Recorded on a Company’s Balance Sheet Under ASC 842
The accounting landscape has dramatically transformed as a result of the adoption of Accounting Standards Codification (ASC) 842: Lease Accounting. Starting in January 2019, this new standard altered the way companies treated leases on their balance sheets. The concept of 'lease capitalization' does not denote a capital expenditure, but rather a requirement to record the full lease liability on the balance sheet at the inception of the lease agreement.
Changes in Lease Accounting with ASC 842
Traditionally, leases were merely expensed as monthly rent payments occurred. However, under the new rules, the entire lease liability must be recognized on the balance sheet. For instance, if a company signs a five-year lease contract for $10,000 per month, the liability would be recorded as $600,000 ($10,000 x 12 months x 5 years) on the liabilities section of the balance sheet.
ASC 842: Lease Accounting Standards Codification
ASC 842: Lease Accounting is part of a broader set of standards created by the Financial Accounting Standards Board (FASB) to enhance transparency and consistency in financial reporting. These standards are the authoritative source for Generally Accepted Accounting Principles (GAAP) in the United States.
FAQs Around ASC 842: Lease Accounting
Why Did FASB Create ASC 842?
ASC 842 was developed as a response to the accounting scandals of the early 2000s, such as the Enron scandal. The primary objective of this codification is to ensure that all contracts and liabilities, including leases, are presented on the balance sheet. Investors, in particular, would benefit from knowing if a potential acquisition subject to a 10-year lease with a significant early termination fee.
Why Should Startups Adhere to ASC 842?
Startups should adhere to ASC 842 because investors and venture capitalists (VCs) expect to see financials presented on a Generally Accepted Accounting Principles (GAAP) basis. As a founder, it is crucial to be aware of all commitments, including the recorded lease liability, which is a key consideration for financial health.
Who Must Comply with ASC 842?
Public companies are obligated to comply with ASC 842. Although private companies, such as startups, are not legally required to adhere to GAAP and ASC, it is advisable to follow these standards for transparency and consistency.
When Does ASC 842 Take Effect?
ASC 842: Lease Accounting was agreed upon by FASB on February 25, 2016. Companies were required to start adhering to ASC 842 as of December 15, 2018, with other businesses following in December 2019. Startups, however, are advised to start adhering to ASC 842 as of January 1, 2019, by recording a lease liability equal to the remaining lease balance on that date. There is no need to adjust prior year tax returns or go back to 2018.
How Much Does ASC 842 Cost to Implement?
The cost of implementing ASC 842 depends on the complexity of the contracts and leases. For straightforward monthly rent expenses, the process can be simple, whereas contracts with inflation adjustments or stepped pricing may be more complex. Expect to pay roughly $2,000 per lease contract to implement the new standard.
Caveat: This article is intended as general guidance for startups and is not a substitute for professional advice. It is a high-level overview and does not cover all aspects of ASC 842 compliance. Each company is unique, and consulting with a Certified Public Accountant (CPA) is strongly recommended.