Embedded Leases and the Lease Accounting Standard
EXAMPLE: Consider a standard product supply agreement. This type of contract might not seem like it contains a lease, but it may include an embedded lease if the purchaser has control over most of the services output.
Be sure you carefully examine all service contracts to assess if there is a lease component. Remember that any term-based easement/contract term could meet the definition of a lease.
So, how does lease accounting influence your balance sheet and leverage ratios?
The main issue is how adopting the standard will increase your balance-sheet liabilities. Depending on how your loan covenants are written, this may have an impact on them. Under general accepted accounting principles, operating lease liabilities are not technically considered debt, but leases that were previously not recognized on the balance sheet will likely now be recognized.
Companies should carefully review their debt covenants, particularly any leverage rationing requirements, to see if the new liabilities will be factored into existing debt covenants.
Allow yourself enough time to fully understand all the implications of ASC 842.
How To Prepare If You Lack Lease Accounting Expertise or Staff
SECURE THE RIGHT EXPERTISE
Consider securing professional assistance to fully execute your implementation activities. Specifically with experience in:
- Project Management
- Technical Accounting (including embedded lease assessments, discount rate estimations, & accounting policies)
- Data Collection
- Processes, Procedures, and Internal Controls
- IT System Selection (or outsource)
- IT System Implementation & Interfaces
WHAT IF YOU DON’T HAVE THE RIGHT EXPERTISE ON STAFF?
- Allow yourself sufficient time to start implementing ASC 842 leases for 2022.
- Examine carefully all service contracts to determine if they contain a lease component.
- Examine your debt covenants carefully, focusing on any leverage ratio requirements, to see whether the new liabilities will be incorporated into current debt covenants.
- Continue forward planning. ASC 842 implementation can be challenging, time-consuming, and resource-intensive.
WORKING WITH SIRIUS SOLUTIONS
Sirius Solutions provides individualized solutions that effectively meet your demands as you transition to the new standard using a scalable methodology that reduces implementation time.
Working with Sirius Solutions means working with experienced Lease Accounting leaders and has numerous advantages. We have demonstrated success in assisting businesses with their ASC 842 implementation, and our team can assist with all aspects of the implementation process.
Our detailed approach reduces risks and potential challenges, beginning with conducting preliminary impact assessments, analyzing and categorizing existing leases, establishing policies and procedures for ongoing lease activity, addressing technology and infrastructure requirements, and project management.