ASC 842, or the Accounting Standards Codification 842, is a set of guidelines established by the Financial Accounting Standards Board (FASB) for lease accounting. It requires companies to report their leases on their balance sheets, rather than just in their footnotes. This standard has been put in place to increase transparency and provide a more accurate representation of a company’s financial health.
However, despite the benefits of ASC 842, many companies struggle with compliance. This can result in costly mistakes that can impact financial statements, relationships with stakeholders, and regulatory compliance. In this article, we will discuss some of the common ASC 842 compliance mistakes companies make and how to avoid them.
1. Not Identifying All Leases
One of the most common mistakes companies make is failing to identify all of their leases. ASC 842 defines a lease as a contract that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. This means that any agreement that meets these criteria, even if it is not called a lease, must be recorded on the balance sheet.
Many companies make the mistake of assuming that only traditional leases, such as office space or equipment, need to be recorded. However, there are several types of leases, including operating leases, finance leases, and subleases, that may be missed if not properly identified. To avoid this mistake, companies should conduct a thorough review of all contracts and agreements to ensure all leases are properly recorded.
2. Incorrect Classification of Leases
ASC 842 requires companies to classify leases as either operating or finance leases. Operating leases are similar to rental agreements, where the lessee pays for the use of an asset but does not have ownership or control over it. Finance leases, on the other hand, are more like loans, where the lessee has both ownership and control over the asset.
The classification of leases is important because it affects how they are recorded on the balance sheet and impacts financial ratios. However, many companies struggle with correctly classifying their leases. This mistake can occur due to a lack of understanding of the standard or not properly evaluating the terms and conditions of the lease agreement.
To avoid this mistake, companies should ensure they have a clear understanding of the criteria for each classification and carefully review all lease agreements to determine their classification.
3. Inaccurate Lease Data
ASC 842 requires companies to report specific lease data on their balance sheet, including the lease term, discount rate, and initial direct costs. This data is necessary to accurately calculate the lease liability and right-of-use asset. However, many companies make the mistake of not recording this data accurately, which can lead to errors in the financial statements.
To avoid this mistake, companies should establish a system for tracking and recording lease data accurately. This can include implementing lease accounting software or creating a detailed spreadsheet to track all lease information.
4. Not Re-Evaluating Leases
ASC 842 requires companies to reassess their lease agreements whenever there is a change in the lease term or conditions. This could include modifications to the lease, renewals, or terminations. However, many companies make the mistake of not re-evaluating their leases, which can result in inaccurate reporting and non-compliance with the standard.
To avoid this mistake, companies should have a process in place to regularly review and reassess their lease agreements to ensure they are properly recorded and classified.
5. Lack of Training and Resources
Another common mistake is the lack of training and resources for employees responsible for implementing ASC 842. This standard can be complex and requires a thorough understanding of lease accounting principles. Without proper training, employees may make mistakes or struggle with compliance, leading to errors in financial reporting.
To avoid this mistake, companies should invest in training for their employees responsible for lease accounting. This can include attending seminars and workshops, hiring outside consultants, or using online resources to gain a better understanding of ASC 842.
In conclusion, ASC 842 compliance can be a challenging task for companies, but it is essential for accurate financial reporting and regulatory compliance. By avoiding these common mistakes, companies can ensure they are properly implementing the standard and providing stakeholders with a transparent view of their financial health. It is important for companies to invest the time and resources to understand and comply with ASC 842 to avoid costly mistakes and maintain compliance.