Adoption of the new lease accounting standard, ASC 842, is around the corner for private companies, and to prepare for the process, you should be taking inventory of all of your organization's leases. After all, ASC 842 will significantly impact how your organization will manage, account for, and report leases.
For private companies the new lease guidance is effective for fiscal years beginning after Dec. 15, 2021, all leases except for short-term leases will be recorded on balance sheets. Some leases — such as the ones for your immediate workspace — may be obvious. Nevertheless, there are many departments at your organization where leases can reside (or hide).
Your organization likely has leases spread all over its operation. The most common area where you find leases is real estate, but another popular spot for leases includes machinery and equipment. Your organization may even have embedded leases, which are harder to find.
The departments in your organization that are most likely to have leases are transportation & logistics, operations, information technology, marketing, and real estate. This article will provide a glimpse into where leases might reside within those departments in your organization.
Transportation & Logistics
If your organization uses commercial vehicles to function, it may use a fleet management system to keep track of maintenance, monitor driver schedules, and improve efficiency. If so, that's a great place to start. Fleet management systems often store lease agreements or at least provide essential details on leases. You should also secure a list of every vehicle at your organization that is currently under lease.
It would also help to look for leases and management systems relating to trains, ships, trucks, and airplanes.
These days, many smaller organizations with limited financial resources find it more beneficial to lease workspace necessities than purchase them to ease the impact on cash flow. This equipment can be office and breakroom machinery and equipment, vending machines, kitchen-related items, and recreational equipment, such as arcade machines like pinball or video games.
Due diligence is critical when walking through this list of inventory. Small items—even coffee pots—may have been obtained via a lease. Do not leave any stone unturned.
With the ever-changing world of technology, it has become increasingly popular for organizations to lease large high-tech equipment, such as computers and printers. High-tech equipment is susceptible to depreciation, with many of these machines becoming outdated the moment they're off the shelf. Leasing is an attractive option for an organization to stay with the times without breaking the bank.
Other popular IT leases include office telecommunications, data centers, servers and data storage, equipment, and outsourcing arrangements (which may include an imbedded lease).
Your organization may use an IT asset management system to keep track of its valuable assets, which keeps records on everything from serial numbers to service contracts. Utilizing this tool will be helpful in your search for leases.
Marketing & Sales
Even marketing and sales departments are no stranger to a lease agreement. Find out if your organization leases advertising, such as billboards or arena or stadium advertising. Keep in mind that the advertising lease may be physical or digital. As explained below, sometimes marketing and sales-related leases may be embedded within other contracts.
Watch Out for Embedded Leases
Identifying embedded leases is one of the most challenging aspects of the new lease accounting standard. Embedded leases are a contract component that is either implicit or explicit in allowing the user to control an asset. Under ASC 842, they are now recorded on the balance sheet. Most organizations unknowingly have embedded leases, and historically, they were often not treated or disclosed as leases. Remember that it will not always be apparent on the surface if a contract contains an embedded lease, so identifying them will take some time, patience, and legwork.
Examples of service contracts that may have embedded leases:
Potential Identified Assets
Freight management services
Cars, trucks, ships, and trains
Storage and logistics agreements
Warehouse space, related equipment
Manufacturing, office, or warehouse space
Servers, co-location data center space
Cable and satellite services
Modems, routers, network equipment
Billboards, arena/stadium advertising
Tips For Your Search
Identifying your organization's leases is not a one-person job, and it should include the help of many employees. Your first stop should be with your organization's procurement or purchasing department to discuss processed orders and obtain a vendor list. Also, be sure to have discussions with department leaders who are involved with procurement requests. Creating an interdepartmental team to tackle the lease inventory scavenger hunt on a larger scale is even better.
One common approach for identifying potential leases is to identify general ledger accounts with recurring payments. This can be accomplished by reviewing transactional information contained in the ledger, and aggregating the spending by each vendor. Identify the population for contract review and analyze for any possible embedded leases included.
Working with accounting professionals can help your organization tackle the intricacies of ASC 842 for a smooth transition and speed up your process of lease inventory. For more information, please contact us.