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Lease accounting for private equity: Five questions to ask now

Implementing ASC 842 for portfolio companies

The fast-approaching deadline for public companies to comply with the new US lease accounting standard is a call to action for private equity (PE) firms. Will you be ready? Consider five questions you should be able to answer before these new lease accounting standards come into play.

Lease accounting for private equity firms

Effective January 1, 2020, Financial Accounting Standards Board (FASB) lease accounting standard, ASC 842, requires non-public company lessees with a calendar year-end to categorize leases as either operating or finance leases and to record virtually all leases exceeding one year in length on their balance sheet. It also modifies the lessor accounting model to achieve greater alignment with FASB’s new standard on revenue recognition.

ASC 842 should be of interest to PE firms now for its impact on portfolio companies due to the potential investment and resources required to comply with the standard. Additionally, management can benefit from considering the potential impacts, if any, to financial performance and underlying valuation. Such impacts could have implications for any of those companies if they are being considered for divestitures, M&A, joint ventures, or other deals.

Likely of foremost importance to PE firms is what the standard means for the valuation of their portfolio holdings. Bringing off-balance-sheet leases that were previously treated with a footnote, if at all, onto the books as liabilities may have some impact on a company’s valuation. For example, the total liabilities to equity ratio is likely to have an increased amount of liabilities with no changes in equity. That matrix probably appeared to look better prior to issuance of the new leasing standard because the lease commitments disclosed in the footnote may not have previously been considered to be a real liability.

Implementation of the standard can require significant investment and attention, both during and after the transition period. ASC 842 compliance is likely to involve new technology or upgrades to existing systems, extensive abstraction of existing lease agreements to capture specific data, and close coordination among portfolio company senior executives in the corporate real estate, procurement, and IT, with third-party advisers involved where necessary.

The new standard requires lessees to establish a liability for each of their leases, including operating leases exceeding 12 months, and an accompanying right-of-use asset. Many organizations historically have not captured, at the required level of detail, the variables necessary to make these calculations, and related disclosures.

Five questions to ask now

PE firm executives who want to determine the readiness of their portfolio companies for ASC 842, or anticipate the standard's potential impact, can gain valuable insights by posing five questions to the CFOs, chief accountants, or head of finance team (hereafter CFOs) of those portfolio companies.

Championing ASC 842 compliance

PE firm executives can help accelerate and streamline ASC 842 implementation by directing portfolio company CFOs to designate a project management office (PMO), which can coordinate and take responsibility for the effort. PMO stakeholders should include representatives from the portfolio company’s accounting, tax, corporate real estate, procurement, and IT functions, along with external auditors.

The PMO can develop a detailed project plan in coordination with the external auditor, then work to ensure that data collection and validation and software implementation remain on schedule. Portfolio company CFOs also may want to appoint a lease liaison—a lease accountant to be responsible for the new accounting and reporting requirements on an ongoing basis.

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The clock is ticking

The new lease accounting standard is expected to increase transparency, but implementing it will be a big undertaking for many companies. For PE firms that might have been monitoring their portfolio companies’ progress on adoption only sporadically, this is the time to put it higher on the agenda.

Clock

The services described herein are illustrative in nature and are intended to demonstrate our experience and capabilities in these areas; however, due to independence restrictions that may apply to audit clients (including affiliates) of Deloitte & Touche LLP, we may be unable to provide certain services based on individual facts and circumstances.

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