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FASB’s Lease Accounting Delay and Private Companies: You’ll Need the Extra Time

A huge exhale! You either heard it or experienced the collective sigh of relief last week when the Financial Accounting Standards Board announced the delay of some rule implementation deadlines, including the effective date for the new lease accounting standard. Now private companies have until January 2021 to adopt ASC 842. So, is now a good time for a vacation? Probably not. View this reprieve as less of a break and more of an incentive to get cracking on accounting for the leases in your company—including the embedded leases you may still need to identify. There is work to be done, and you now have a bit more time to do it right.

It turns out that private companies truly need this “extra” time to implement the new standard, which public companies found to be more confusing and complicated than first expected. Several aspects of the rule tripped up public company lessees as they scrutinized their right-of-use assets and associated obligations and considered whether to move them out of the footnotes and onto their balance sheets. They wrung their hands over looking more leveraged and the best way to explain that to their investors. And they found themselves right up against the deadline for powering through what turned out to be quite a complex effort.

Why Private Companies Need More Time

FASB’s announcement that it’s delaying the effective dates of the lease accounting rule (in addition to other standards for credit losses, hedging, and some insurance contracts) wasn’t a surprise. The board proposed making these deferrals back in August.

While it was fair to feel relief when the announcement came through, this isn’t the time to procrastinate. The time that FASB is giving private companies is needed—all of it. Implementing this standard is so much harder and trickier than you think. Public companies, whose deadline for the leasing standard was this past January, found this out when they went through their implementations, and they needed a lot more resources to dedicate to this big project.

With the new extension, private companies have an opportunity to benefit from what public companies learned during their implementation efforts, be more deliberate in their efforts, put a smoother process in place, and possibly experience fewer questions by their auditors than they would have under the original time crunch.

The fact is that implementing the new lease accounting standard is challenging. Public companies struggled with a range of issues, from spending too much time on immaterial arrangements to inadvertently overlooking agreements that needed a closer look. Common challenges with the new way of accounting for leases include:

  • Finding embedded leases: Not every agreement at a company that would be considered a lease under the newest version of GAAP is explicitly labeled that way. For a service arrangement that spells out you have a right to use a particular asset and that asset cannot be substituted, you could have an embedded lease—if the vendor owns the asset but you control the economic benefit of the asset for a defined period of time. Some companies wrongly assume they don’t have embedded leases in service contracts or don’t realize how complicated it is to identify their embedded leases. And once you do find them, you’ll need an ongoing process for keeping tabs on embedded leases.

    Bottom line: If a contract includes a promise of an asset for a specific period of time, without substitution, it could qualify as a lease. This means companies need to look at their vendor arrangements for the possibility of embedded leases and come up with lease terms to describe those arrangements. Depending on the size of the company and its contracts, this could be a lengthy endeavor.
  • Accounting for costs: Another common challenge has involved recording expenses around lease agreements. ASC 842 tightened the definition of initial direct costs for obtaining a lease. These are the incremental costs of a lease that wouldn’t exist without the lease. Fewer lease origination costs will be capitalized under ASC 842 compared with ASC 840. The costs involved in negotiating or setting up a lease don’t count here, and separating these out will require close scrutiny. Having advised public companies in their recent ASC 842 implementations, RoseRyan can provide insights in this area as well as the others on this list.
  • Figuring out the incremental borrowing rate: Coming up with the incremental borrowing rate can be tricky as it’s not typically stated for an operating lease. This is “the rate of interest that a lessee would pay to borrow on a collateralized basis, over a similar term, at an amount equal to the lease payments, in a similar economic environment.” But there may not be a market benchmark to go by for, say, an office space. So, as the lessee, you may need to do some digging to factor in current market conditions and what interest rate a bank would charge your company as you determine this figure.
  • Researching technology options: Software options for keeping track of lease obligations are plentiful, and time is needed to figure out which one could be best for your company.

Lease Accounting: Next Steps

For private companies that haven’t yet started implementing ASC 842, now is the time to put a thoughtful plan in motion. Taking on the lease accounting standard can require input from all sides of the business while also educating other functions about what falls under the new standard. The finance team needs help, time, and resources as you work through understanding the various business arrangements that may contain embedded leases. There may be a need to revisit how agreements are made between the company and vendors. And you may want to include the insights of the IT team to bring in a new system.

Finance and accounting pros who have helped public companies through the process and know how to conquer the standard’s toughest challenges can be an incredibly valuable resource through it all.

For more key takeaways for private companies in the midst of adopting the leasing standard, check out the webinar “Get a Handle on Revenue Recognition and Lease Accounting Before It’s Too Late.”

As RoseRyan Director of Strategic Projects, Brooks Ensign oversees the growth and leads the team of a broad array of our finance and accounting solutions, including our highly regarded Technical Accounting Group. Before joining RoseRyan, Brooks served as an interim controller and SEC reporting consultant for both public and private companies. He was also the controller of Nervana Systems, an artificial intelligence startup that was acquired by Intel, and he led international corporate development transactions at Valeant Pharmaceuticals.

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5 tips for finding financing with the right investors

Companies are under the microscope from the moment they attract a key investor. “Potential investors are making assessments and determinations throughout the whole process—not just right at the start,” RoseRyan director Stephen Ambler warned during a recent webinar. “You’re under the spotlight for quite a period of time,” he added.

For private companies on the funding hunt, their quest is especially tough during the early stages of searching for investors and the process for connecting with them and winning them over. It’s an infrequent occurrence for the team involved, who has to pull their attention from their day-to-day work. And it’s a process that’s rife for possible setbacks as a mismatch could add to the time the company has to wait for much-needed funding.

Here are just a few of the tips Stephen offered in his webinar:

1. Start early.

A last-minute, desperate search is more likely to lead to a bad deal—or no deal at all. Securing financing can take a long time, between three and six months. Build in time to both prepare your company to find the right investor (or a few—as a deal may fall apart), and undergo detailed scrutiny when you do.

2. Get your house and business plan in order, and be prepared for an open conversation.

You should have both up-to-date documentation and your business plan for the next two to three years in place. Not only do you want to show you have good records, but you want to show potential investors a plan, with support, that is attractive, realistic and achievable. They won’t invest unless they see that.

You also need to lay out any dirt you have for possible inspection. No one expects a perfect world, so be open and honest. Investors will not be pleased to find out about a lawsuit after they’ve agreed to work with you. Potential investors want to know where the possible holes are in your business, and they want to be fully aware of any reputational risks they’re taking on once they sign the dotted line. “No investor wants their name in lights,” Stephen said.

3. Seek out the perfect match.

Many investors will only go with companies that fit within the boundaries they have set up for themselves. They might consider only late-stage companies, for instance, or companies that are in a particular industry or already have a rigid exit plan.

Fortunately, many investors explain their parameters right on their website. You can also ask around, to your current investors, board members and trusted advisors, for recommendations. A warm introduction is ideal—cold calling around for your next investor will be time consuming and is less likely to be effective.

4. Make a good first impression.

Professionalism goes a long way with investors who want assurance that your company is on the up-and-up. That first meetup is where the first impression truly counts. A company once called Stephen for help in frustration that they couldn’t get financing. Part of the problem: They had a habit of dulling investors with over two hours of slides. Nearly 60 pages, in fact!

“Your key facts should not read like War and Peace,” Stephen said. “No one wants to see that—it sends a bad signal.”

In just 15 professionally designed slides, you can fit in essential details while showing off the passion the team has for the company, its mission and prospects.

5. Be ready for an onslaught of scrutiny.

If investors are interested, that’s when the real questions will begin as they conduct their due diligence. This is where any prep work you did ahead of time can help tremendously.

Investors want to see key metrics to fully understand how the business is managed and whether they can stand behind it. In addition, you will need basic information that’s up to date and at the ready to keep the potential deal on track—including management accounts, revenue by product, receivables and payables.

Talk about a huge undertaking! Finding and securing investors consumes more time than many executives new to the process realize. They can save some valuable time and increase their chances of making a promising investor match by checking in with trusted advisors who have helped with similar deals and are on top of the trends in the investment community.

The right investor could be just around the corner—you just need to know how to find and keep their interest.

What happens after you find the right investor? Listen to the online webinar “Attracting Funding: What Does an Investor Look For?” at your convenience to hear Stephen’s advice before signing the term sheet and learn important tips about what investors look for as they scrutinize potential investments. This event was originally broadcast on December 15, 2016 and was hosted by Breakaway Funding.

Stephen Ambler is a director at RoseRyan, where he oversees the CFO practice area and handles client CFO requests. He has over 30 years of experience helping a wide range of companies with their financing needs. His interim CFO stints at RoseRyan have included a social media company and the management of the financial integration process at a company acquired by Oracle. He previously held the CFO position for 13 years at NASDAQ-listed companies.

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