How ASC 842 May Affect Your Decision to Lease or Buy

How ASC 842 May Affect Your Decision to Lease or Buy

With ASC 842 in full effect, your lease versus buy decisions have become more complicated and they will impact your balance sheet, income statement, financial reporting, and more.

Senior VP of Lease Management Strategy at Visual Lease (a lease accounting software company) Joe Fitzgerald summarizes the situation this way, “For the first time ever, public and private companies, as well as government entities, are required to disclose asset and liability details for anything they pay for the right to use—including real estate, equipment, fleet and land leases—on the balance sheet under the new lease accounting standards.”

He continues, “This is easier said than done as leases are complex agreements that change all the time, and they’re managed by siloed stakeholders, processes, and systems. Not to mention, lease transactions can have hundreds of permutations and calculations to capture in reports and throughout the year in order for a company to successfully achieve and sustain lease accounting compliance.” (Pelovitz, Rachel E. Lease Accounting Readiness: A Report. November 7, 2022. Construction Executive.)

Joe also notes that failing to meet and maintain lease accounting compliance can compromise the accuracy of financial reporting and result in higher audit fees, not to mention a damaged reputation., a finance and accounting application developer, summarizes key accounting impacts this way:

  • “Both leasing and purchasing recognize an asset and liability.
  • A lease will be recognized under the ROU asset and lease liability accounts, while purchasing is recognized under the fixed asset and note payable accounts.
  • The asset and liability for an operating lease would typically be smaller because the lease term would not be for a significant portion of the asset’s useful life
  • Otherwise, it would be classified as a financing lease.”

In addition, “On the income statement, an operating lease will be classified as an operating expense. This means that EBITDA and net income will be impacted. If a company were to buy an asset, the expense would be allocated to interest and depreciation expenses. These expenses are below the EBITDA line, which means that they only have an impact on net income. Because many companies are valued on multiples of EBITDA, it becomes a very important decision whether to lease or buy assets because it would have a direct impact on your valuation (sometimes a 15x swing, for better or worse).”  (Triton, Lee. Deciding to Lease or Buy an Asset: Financial Statement Implications. September 14, 2022.

When it comes specifically to fleets, workplace, and asset management software company Accruent reports,” What makes lease accounting complicated is that within a single master lease agreement for a fleet, individual items, and assets are constantly moving in and out of the lease. Previously, the financial accounting system did not have to be concerned with that, as the assets remained off the balance sheet.”It goes on to give example: a trucking manufacturer signs a 10-year master lease agreement for 50 tractors, which are ordered, delivered, and put into service. A change in business strategy 10 months later drives the need for 40 additional box trailers added to the lease, plus 10 cars for salespeople and executives.

“These bulk transactions, each with different lives (tractors 10 years, box trailers 7 years, and automobiles 5 years) need to be accounted for at the asset level. This is particularly important and challenging when one-off changes occur. Properly making those individual changes is an operational challenge. On top of that, those changes now impact the needs and functionality of the accounting software. Lease accounting now needs to occur not just on the macro level, but on the micro, or individual asset level, as well.” (Hammerslag, Mike. How Fleets Are Addressed Under the New Lease Accounting Rules.

That’s a lot to take in, but RBT CPAs is here to help. Our client advisory services team can help you understand the financial pros and cons of making a lease versus buy decision, while our accounting, tax, and audit professionals can help with financial calculations and reporting required under ASC 842. To learn more, give us a call today.