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Liz on Leases – Steps to Ensure Completeness of Your Lease Population

After detailing why private companies will soon be required to adopt the Financial Accounting Standard Board’s (FASB) new standard, Accounting Standards Codification (ASC) Topic 842, Leases, Liz Gantnier offers some insight on what companies should consider when making their lease accounting game plan. Here is part two of the “Liz on Leases” Q&A.


Q: What is the first step a private company should take in creating a plan for implementing ASC 842?

L.G.: Companies should first think about identifying their lease population. Before you can develop a strategy, you must know how big of an “ask” this is going to be and if you can manage the workload internally. You might end up considering outsourcing part of it.

Q: So how should a company organize their lease population to help ensure completeness?

L.G.: I think about leases in two categories. The first are the leases that “you know.” These are the contracts that you have already been accounting for as leases under the original legacy standard (ASC 840). Identifying them should be easy, depending on the documentation you have retained. If you have historical GAAP financial statements, you could reconcile your population to the leases disclosed in your lease footnote. Additionally, you should consider reconciling your rent expense accounts against the lease footnote to ensure that even immaterial leases have been captured.

Q: And why is it important to capture immaterial leases?

L.G.: Occasionally, immaterial items are not captured in the footnotes, yet they are still considered leases and may be included in rent expense (or another similar account). You’ll want to capture these to determine the impact they will have on your financial statements under ASC 842. In other words, now that they are recognized on the balance sheet, they may not be immaterial anymore.

Be sure you’ve considered any financial statement line items that appear to be related to a lease – amounts prepaid or on deposit, leasehold improvements, tenant improvement allowances, deferred rent and the like. If you've been keeping picture-perfect records, all these items will reconcile and provide evidence that you’ve identified the complete lease population traditionally accounted for under ASC 840. In a related matter, pay special attention to leases for which the documentation is not up to date, or even non-existent – a very common occurrence for related party leases.

Ensure you’ve considered any financial statement line items that appear to be related to a lease – amounts prepaid or on deposit, leasehold improvements, tenant improvement allowances, deferred rent and the like.
Q: What if your records aren’t picture-perfect?

L.G.: If that is the case, you may have some anomalies with various pieces of information. Your goal is to have a thorough plan to evaluate the leases accounted for under ASC 840 and a documented trail of your thought process using all the evidence at your disposal.

Q: What types of considerations should we be aware of when gathering this info?

L.G.: Similar to the new revenue recognition standard (ASC 606), lease accounting is predicated upon having an enforceable agreement in place. Take care to think through if you have clearly documented contract terms, and an up-to-date agreement that is properly executed. It would be a shame to get too far down the line only to find out that the agreement is, for whatever reason, not considered enforceable. Also, consider if any changes to the agreement have been properly memorialized. It’s possible you may need to “re-paper” any contracts that are missing, incomplete, vaguely worded, out of synch with your current understanding or just out of date. Lastly, it is time to start determining the characteristics of your population. You can do that by asking, “Are they all similar? Is there a lot of variety? Are they complex or simple to manage?” I’ll come back to that point in a minute.

Q: After the leases that you “do know” – what comes next? The leases that you “don’t know?”

L.G.: Exactly! These leases are referred to as “embedded” leases – leases that are embedded inside other contracts. Maybe they’re “hidden” in a contract called “billboard advertising” or “postage machine” and have been expensed to advertising and postage – and not evaluated for lease accounting under the original standard. Finding embedded leases is going to take real effort because you're going to have to go through general ledger expense accounts to ensure that each contract within each expense account has been evaluated for an embedded lease.

Q: Do you really have to look at every contract in every expense account to find embedded leases?

L.G.: The decision of what to inspect should be based on risk identification. Pretend for a moment that we have a population of 800 expense accounts. One approach would be to examine each embedded contract; but, for that many accounts, the approach is not very realistic. A more manageable methodology would be to evaluate each account and assign a risk factor – such as high, moderate or low – representing the risk of that account containing an embedded lease. For example, payroll expense likely doesn't have any underlying assets associated with it; therefore, you could assign a low risk to all payroll expense accounts. Because they are such a low risk, you would conclude you do not need to examine those accounts any further. However, there may be accounts that have a moderate or high risk. These accounts would need extra scrutiny.

Q: Can you give an example of how to identify a high-risk of an embedded lease?

L.G.: Let's say that while examining your general ledger, you discover that, in addition to the primary rent expense account (the one that ties to your footnote), you have three other rent expense accounts. You might assign these a high risk because the name of the account implies there are embedded leases. The lease standard has criteria for a contract to be considered a lease – such as the right to use and control an underlying asset. Therefore, if you know the company has billboard advertising, you may designate Advertising Expense as high risk. It is likely you wouldn’t inspect every amount in that expense category – only those amounts that relate to your billboard vendor. I’ve seen expense accounts called “equipment expense.” These could have an underlying asset that the company has the right to use – perhaps copiers or other office equipment. I’d classify these as high-risk and scrutinize them further. Start with your entire population of expenses and narrow it down using risk (and common sense). This will result in a systematic and thorough approach. You will have a reconciled population of expenses and a priority of researching the contracts within the high-risk categories.

Q: I thought identifying embedded leases was possibly time-consuming, but this seems like it could be overwhelming!

L.G.: You can imagine that, depending on how complex your business is and how extensive your general ledger is, this could take a lot of time. Like before, you've got to gather the underlying documents, ensure they are up to date and properly executed and then spend some time evaluating the contract against the criteria in the standard to determine whether you have a lease.

Q: Is there a way to determine how much approximate time this will take?

L.G.: To determine how much time this could take, I would start by considering the volume, variety and complexity of your population. It goes without saying that if you have a lot of leases, it will take more time than if you only have a handful. If each of your leases are different than the next, then they may each need to be evaluated. If one category is all the same, then perhaps a deep dive into just a few of them, rather than all, would suffice. Lastly, should your lease contracts run multiple pages and have intricate terms, be aware that it could take quite some time to work through each complicated lease contract. Here’s a handy tool that can give you a sense of how many hours this may take. I’ve applied some general time and percentage estimates, just to show you how you might calculate an approximate time commitment. Remember that you need to budget not just for the data gathering exercise, but also time to review conclusions and overall project management. In this example, I have assumed real estate leases will take (depending on complexity) two to five hours to evaluate and equipment leases one-half hour to two hours – also depending on complexity. I have assumed review time is five percent to 25 percent, and project management would be one percent to 20 percent, depending on your circumstance. You should adjust these estimates to be more akin to your situation.

Lease Type
& Total
How Many are
Low Complexity?
How Many are
High Complexity?
Evaluation Time
RE: 2 to 5 hours per lease
EQ: ½ to 2 hours per lease
Total Evaluation Time Review Time
( 5% - 25% of subtotal)
Project Management Time
(1% - 20%)
Estimated Total
Real Estate
5 20 5 at 2hrs each
plus 20 at 5hrs each
110 hours x 20%
22 hours
132 x 10%
13 hours
Equipment Leases
12 3 12 at 1/2hr ea.
3 at 2hrs each
12 hours X 10%
2 hours
14 x 10%
2 hours
Estimated project total             161 hours
Q: Is it a good idea for businesses to think about exploring “the ask” now?

L.G.: Yes, the sooner the better. And personalize the grid to make sense for your situation. If your people are really trained up on ASC 842, your review time may be at the lower end of the scale. If not, it could take more time. If the total number of hours gives you pause, and you think you want to outsource all or some of this work, we’ll talk best practices for deciding how to involve third parties next time.

How DHG Can Help with Your Lease Accounting (ASC 842) Implementation

Learn more about how FORVIS can assist with your lease accounting requirements, including:

  • Lease Identification
  • Lease Classification
  • Lease Review & Contracts
  • Lease Calculations

to discuss your lease accounting implementation needs

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