Not only are material prices and labor shortages top of mind, it is important that construction companies also take time now to address their leasing arrangements. The Accounting Standards Codification (ASC) Topic 842, Leases standard (ASC 842) will be effective for most private companies in 2022 and will impact the financial statements and operations for construction companies. Companies should start working toward implementation as soon as possible to encourage a smooth transition.
To help you build your strategy, DHG has provided a list of considerations for your review. Our team of professionals is well-positioned to help you further assess how the standard will impact your business and provide guidance and insight on all aspects of the lease standard implementation.
Top Considerations for Implementing the Lease Standard
- Lease population: If your company has a history of leasing assets, these leasing arrangements may be short term or span several years, encompassing a variety of renewals or modifications. Upon the adoption of ASC 842, all leases will be accounted for on the balance sheet (see short-term lease exception below), including leases embedded within other service arrangements. How leases make their way onto the balance sheet is highly data-dependent, so it is critical that you identify the current lease population and ensure that your calculation data is accurate. This process may be time consuming so planning for this process as soon as possible is critical.
- Financial covenant considerations: If your enterprise has debt and/or bonding arrangements contemplating working capital or debt to equity ratios, the adoption of ASC 842 may impact those arrangements, and you should begin conversations with lenders and bonding agents to discuss ASC 842 and your financial covenant compliance. In some cases, lenders and bonding agents will exclude the impact of the adoption of the new leasing standard on existing covenant compliance, but this is not guaranteed. Early conversations with appropriate parties would be prudent, and any interpretations regarding ongoing financial covenant compliance requirements should be memorialized in writing.
- Portfolio of contracts: Under certain conditions ASC 842 provides for a portfolio approach, allowing you to account for several lease arrangements as though they are one. If you can establish that a group of leases are similar in nature, have identical or nearly identical contract provisions and that accounting for the group of leases together would not materially differ from accounting for the leases individually, the portfolio approach may be applied.
- Software solution: Based on the number of leases you may be required to account for under ASC 842, consider using a software solution to calculate and track various pieces of information necessary for accounting and disclosing your leasing activities. You should start evaluating whether a software solution will be necessary to comply with the reporting requirements of ASC 842. Many such solutions also provide additional operational and information benefits for your lease management workstreams.
- Related party leases: The accounting for related party leases is different under ASC 842 in that related party leases are accounted for based on the legally enforceable terms of the arrangement. If you have related party leases with limited or no documentation, or arrangements that are “evergreen” or “perpetual,” it may raise questions as to whether such arrangements are legally enforceable. You should prepare a population of all related party leases currently in existence and clearly document the intended terms before the implementation of ASC 842, including an establishment of the lease term. Related party lease arrangements with poorly documented terms may result in unanticipated financial reporting consequences upon the adoption of ASC 842.
- Transition method: There are two transition methods available for implementing ASC 842: comparative and non-comparative. The comparative approach will result in restating all prior period (comparative) financial statements presented to reflect consistent accounting treatment for leases. The non-comparative approach will result in accounting for leases under ASC 842 beginning with the year of adoption without restating prior periods (non-comparative), resulting in presentation under two separate standards. When evaluating the available methods, consider users of your financial statements and resource allocation.
- Practical expedients: There are a variety of practical expedients for transitioning to ASC 842. These expedients may ease the transition burden, but there are implications for transition and go forward accounting depending on the expedients elected or not elected. Available expedients include:
Construction companies should become familiar with these practical expedients and the ramifications of their election choices.
How DHG can help
DHG understands the many facets of the new lease standard and can provide comprehensive guidance specifically for your company and goals. Your lease standard implementation strategy may include an in-depth analysis of the impact to your business and implementation plan and an accounting policy and disclosure roadmap. DHG can also help with:
- Lease standard implementation training
- A tailored lease consultation regarding ASC 842
- Artificial intelligence (AI) powered data extraction and discount rate assistance
- Software solution evaluation and implementation
- Transition adjustment calculation
- Lease schedule preparation
- Internal control and process recommendations
To learn how you can best prepare for the new lease standard, please reach out to us at email@example.com to schedule a conversation.