Impact on Financial Statements and Ratios
Navigating Balance Sheet and Income Statement Adjustments
The shift in lease accounting practices significantly influences your franchise’s financial statements. This change primarily affects the balance sheet, where lease obligations now appear as liabilities, and corresponding right-of-use assets.
These adjustments can alter crucial financial ratios, such as debt-to-equity and return on assets, impacting how lenders and investors view your financial health. Understanding these implications is key to managing perceptions and maintaining robust financial strategies. It’s not just about compliance; it’s about smart financial storytelling.
How to Gauge if ASC 842 Might Apply to Your Business
This new standard will most likely impact your business or franchise, so let’s break down how it applies specifically to restaurant and retail owners.
1. Lease Agreements: What You Lease Matters
ASC 842 primarily targets lessees, those entering lease agreements to use assets or spaces. For restaurant and retail owners, this includes leases for crucial elements like real estate, equipment, or vehicles, including sales type leases. If you’re leasing any of these, ASC 842 likely applies, influencing how you account for these assets on your balance sheet.
2. Lease Term: The Long and Short of It
ASC 842 is concerned with long-term leases, typically those exceeding 12 months. If your business mainly engages in short-term leases—say, for a pop-up store lasting less than a year—you might catch a break. Short-term leases that you choose not to recognize on the balance sheet could be exempt from ASC 842 reporting.
3. Materiality Thresholds: Size Doesn’t Always Matter
While a materiality threshold exists, don’t be too quick to assume your smaller leases fly under the radar. Even seemingly modest leases may require disclosure in the footnotes of your financial statements. It’s essential to carefully assess the value and impact of each lease.
4. Lessor vs. Lessee: Know Your Role
For those leasing out assets, ASC 842 is less directly applicable. However, if your business primarily acts as a lessee—leasing spaces, equipment, or vehicles—get ready to navigate the accounting changes. Even lessors need to be aware of potential impacts on lessees, shaping how business relationships unfold.
5. Intangible Assets: Beyond the Tangible
Leasing isn’t limited to physical spaces and equipment. Intangible assets, such as software licenses, patents, or trademarks, may also fall under ASC 842. Carefully reviewing lease agreements involving intangible assets is essential to ensure compliance.
6. Low-Value Leases: Small but Significant
Good news for businesses with numerous small leases—ASC 842 includes a practical expedient for recognizing low-value leases. If the value of the underlying asset is considered low, you may opt not to recognize it on the balance sheet. This provides relief for those juggling numerous smaller leases.
7. Public vs. Private Companies: Timelines Matter
Effective dates for ASC 842 implementation vary for public and private companies. Public companies likely adopted the standard earlier, while private companies have their own timelines. As a restaurant or retail owner, be aware of your company’s status and the relevant effective dates to stay ahead of the game.
Carefully reviewing lease agreements, considering lease terms, materiality, and the nature of leased assets is essential for restaurant and retail owners. If uncertainty lingers, consulting with an accounting professional can provide clarity and ensure your compliance with ASC 842.
Transitioning to the New Lease Standard
Step-by-Step Guide for Smooth Adoption
Transitioning to the latest lease accounting standard is a multi-step journey. Start by gathering all your lease agreements and extracting key data points. Next, focus on recalculating your lease liabilities and assets in line with the new criteria.
This phase may require retroactive adjustments and a thorough review of your financial history. Tools like Leasecake can simplify this complex process, offering an efficient pathway to reorganize and report your lease data under the new standard. Remember, a smooth transition sets the stage for ongoing compliance.
Consequences of Non-Compliance with ASC 842
Failing to comply with ASC 842 can lead to various consequences for your franchise, including financial reporting inaccuracies, potential legal consequences, and challenges with audits.
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- Financial Reporting Accuracy: ASC 842 aims to enhance financial reporting accuracy and transparency. Non-compliance may lead to misleading financial statements, impacting how stakeholders and investors perceive your business.
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- Audit Concerns: Non-compliance with accounting standards can trigger audit issues, with auditors identifying weaknesses in internal controls. This can diminish confidence in the reliability of your financial statements.
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- Legal and Regulatory Risks: Regulatory bodies may impose fines for ASC 842 non-compliance, considering it a violation of financial regulations. Restaurant and retail owners need to be vigilant to avoid legal consequences.
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- Investor Trust Erosion: Inaccurate financial reporting can erode investor confidence. Stakeholders, including investors and creditors, rely on accurate financial statements for informed decisions. Non-compliance may result in a lack of trust in your business’s financial disclosures.
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- Contractual Breaches: Lease agreements often include covenants tied to financial reporting. Non-compliance with ASC 842 may breach these contracts, leading to penalties outlined in lease agreements for restaurant and retail owners.
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- Financing Implications: Lenders and creditors closely scrutinize financial statements. Non-compliance with ASC 842 could impact your ability to secure financing or renegotiate credit agreements, potentially leading to higher borrowing costs.
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- Operational Challenges: Non-compliance brings operational challenges. Failing to implement ASC 842 systems and processes can make it difficult for restaurant and retail owners to manage leases, track financial obligations, and make informed strategic decisions.
Employing a robust lease accounting tool, such as Leasecake, can help avoid these consequences and ensure ongoing compliance with ASC 842 standards as well as other lease standards.
Best Practices for Ongoing Compliance
Maintaining Accuracy and Timeliness in Reporting
Consistent compliance with the updated lease standard demands vigilance and strategic processes. Regularly review your lease agreements for any changes that might affect reporting. Stay abreast of any amendments to the standard and adapt your practices accordingly.
Key to this is an educated and well-informed accounting team, supported by robust software tools. These tools not only track lease terms and payments but also provide alerts for critical dates and changes, ensuring that your reporting remains accurate and timely.
Download the Free Guide: Secrets to ASC 842 Compliance
Our team of real estate experts has compiled the steps your team should take to get up to speed with ASC 842.
Mitigating the Risks
To navigate ASC 842 successfully, be proactive. Understand the standard, implement necessary changes, and consider seeking guidance from accounting professionals. Regular training for your finance and accounting team is crucial for ongoing compliance.
Specialized software solutions, such as Leasecake, facilitate seamless navigation of lease accounting 842 standards for restaurant and retail operators.. Our customers love how easy to use it is, and how quickly they can pull reports and integrate their data with other platforms like R365, Quickbooks, and Netsuite.
One of our customers, Jeff Springer, CPA and Accounting Manager at Ruby Slippers Cafe, says, “Leasecake is a dynamic tool that allows us to generate rent schedules for any location in
minutes. It’s helped us have more financial clarity as we’ve built new locations.” Read more in the Ruby Slippers case study.
