ASC 842 Explained: How the New Lease Accounting Standard Transforms Transportation & Logistics

The Financial Accounting Standards Board’s new lease-accounting standard, ASC 842, went into effect for public transportation and logistics companies last year. FASB recently proposed extending the deadline for private companies for one year to annual periods beginning after December 15, 2020, which, as of August 2019, was still undecided. The new rules replace ASC 840, which has been used for more than 40 years, and changes the way businesses must account for finance (capital) and operating leases, moving almost all leases to the company balance sheet.

Previously, operating leases could be reported as a footnote in corporate financial statements, not affecting 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 company financial statements. Even for public companies that made it through the first year of compliance, many are still struggling with developing repeatable processes to ensure continued compliance.

Transportation and logistics companies face significant challenges to ASC 842 adoption and compliance, due to the extensive and diverse types of lease assets that are central to the business. Everything from vehicle and equipment leases to leased storage units, airplanes, and ships will be affected by the change. According to the International Accounting Standards Board, companies are expected to bring upwards of $3 trillion in operating leases onto their financial statements due to the new accounting rules. Companies with large amounts of operating leases, such as logistic companies that lease airplanes, cars, and ships, will be especially impacted. Underscoring the enormity, four top publicly traded logistics companies alone moved nearly $5.2 billion in leases onto their balance sheets as a result of ASC 842.

Complicating matters even further is a slightly modified definition of a lease. Under ASC 842, “[a] contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (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, transportation and logistics companies will experience the following:

• Accounting policy and practice changes. Most transportation and logistics companies will have to examine and update their accounting policies and practices to align with the new standard. It's equally as likely that they will also have to perform additional analysis to determine how to apply the standards to certain leases.
• An increase in balance sheet assets and liabilities. ASC 842 requires that both operating and finance leases be capitalized on the balance sheet. The only exception is certain short-term leases that are 12 months or less in duration. Right-of-use (ROU) assets will be recognized on the balance sheet along with a corresponding liability.
• Income statement changes. The new rules generally result in a straight-line expense profile for operating leases and a front-loaded profile for finance leases. Interest and amortization expense will be presented separately on the income statement for finance leases, whereas the two are combined and presented as a single line-item for operating leases.
• Lessee/lessor responsibilities. Transportation and logistics companies are in the unique position of potentially being both a lessee and lessor. A close examination of the contract terms will be necessary to assess whether or not the arrangement is a lease, and to identify the necessary financial reporting requirements of each lease. Arrangements may also contain lease and non-lease components that require different accounting applications.
• Sale-leaseback changes. There have been changes as to what qualifies as a sale-leaseback transaction. Under the new rules, a purchase occurs when: (1) there is a contract and control has transferred per the guidance in the new revenue recognition standard (ASC 606), (2) the leaseback is not a finance lease, and (3) a repurchase option, if any, is exercisable at the asset's fair value, and a substantially similar alternative asset is readily available in the marketplace. In this case, lessees should derecognize the asset and record a gain/loss on sales as appropriate. If no sale occurs, lessees do not need to derecognize the asset and should reflect the transaction as borrowing. Lessors should reflect their cash payments as loans.

Although private companies are not expected to have to comply with the new standards until annual periods beginning after December 15, 2020, public companies had to begin complying for annual periods beginning after December 15, 2018. Their experiences give private companies some insight into the challenges of compliance. Among the biggest lessons learned so far has been a tendency to underestimate the amount of time needed to successfully transition to the new standards. Transportation and logistics companies must give themselves enough time to develop new lease reporting methods, policies, and practices so as not to miss any leases. Collecting and organizing this data is time-consuming ,and accuracy is essential.

Based on the experiences of companies that have already transitioned to ASC 842, the transition can be eased by adopting some best practices:

1. Develop a comprehensive plan for transition. Companies that developed a plan of action for the transition fared better than those that did not. Involve finance and accounting teams, business leaders, and managers who oversee leases in plan development, to accurately assess current and future lease obligations.
2. Anticipate and evaluate complexities. The ASC 842 transition is rife with complexity all on its own. Once the additional complexities of transportation and logistics leases are added in, the situation becomes even more challenging. Start the transition early, and take advantage of the practical expedients available to achieve compliance sooner.
3. Avoid common stumbling blocks. Some of the most common stumbling blocks include identifying embedded leases, determining incremental borrowing rates, and sale-leasebacks. Plan to spend a significant amount of administrative time identifying embedded leases, incremental borrowing rates for all leases, and the accuracy of sale-leaseback transactions.
4. Invest in new “accounting-first” systems that can scale with you as your company grows. Early adopters in public transportation and logistics companies reported dated or flat-out faulty technology as a huge issue in lease accounting compliance, introducing financial statement risk. In fact, errors in the software was one of the primary reasons that the AICPA urged FASB to extend the deadline for ASC 842 for private companies.

One of the reasons these errors are being made is the absence of an “accounting-first” approach. Many of the existing leasing systems claiming to handle the new lease accounting standards are lease administration systems that quickly added on accounting capabilities to sell more software. Businesses are finding issues with the systems because they weren’t built as accounting-first systems. Look for lease accounting software solutions that are built by reputable accounting and tax software vendors who have the accounting and tax experts on staff.

ASC 842 is here to stay. Although the accounting changes are the most obvious impact to transportation and logistics companies, they aren't 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, and data collection and reporting. This is an opportunity to reshape and improve the way transportation and logistics businesses function for more streamlined, accurate, and efficient lease management and continued success.

Adam Schrom is Senior Manager at Bloomberg Tax & Accounting.