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ASC 842 Legal Implications: What Lawyers Must Know About Lease Accounting

ASC 842 Legal Implications

For most corporate attorneys, FASB ASC 842 compliance is an accounting exercise that is only vaguely on their radar (if at all). Here is why that is as a major mistake: there are significant ASC 842 legal implications that put companies, as well as their officers and boards, at risk.

Visual Lease is a lease accounting solution that was developed by attorneys & accountants, so we are hyper-focused on avoiding the potentially disastrous consequences of lease accounting mistakes. At virtually all the companies we talk to every day, the FASB ASC 842 compliance effort is driven by accounting and SEC compliance teams with very little input from the legal department. In our view, this is worrying, to say the least.

In this article, we will explain some of the important ASC 842 legal implications, what corporate attorneys need to know about lease accounting, and how they should be protecting the company by getting involved in FASB ASC 842 compliance efforts.

Why corporate attorneys must understand lease accounting and ASC 842 legal implications.

Let’s begin with a quick explanation of the significance of FASB lease accounting compliance for the company.

ASC 842 is FASB’s new accounting standard for leases, which is slated to take effect in January 2019 for public companies and a year later for private companies.

While leases are significant commercial agreements and important operationally (especially real estate leases), until now leases were not important for accounting. That is because lease payments do not appear on the balance sheet under the current accounting standard.

That is all changing under the new ASC 842 standard. Leases must now be brought onto the balance sheet, so they are visible to auditors. Lease agreements now impact the company’s financial reporting and are subject to Sarbanes-Oxley.

Anything less than an unqualified approval from a financial auditor has major consequences for your organization. When it is time for a financial audit, you must be sure all your numbers are correct. In addition, you must be able to show that you followed all the right processes to validate the data used in your financial calculations.

Our advice to corporate attorneys? Do not let your accounting team do this without your input.

As legal counsel, your job is to protect the company, its officers and board members from exposure and even personal liability due to improper financial reporting. That is why it is essential for corporate attorneys to understand the ASC 842 legal implications and to provide guidance for the lease accounting process.

Here is what you need to know.

3 things corporate attorneys need to know about lease accounting

#1 How to identify a lease

There are ASC 842 legal implications for contracts that do not look like leases. For accounting purposes, certain types of agreements may count as a lease, even if the word “lease” never appears.

For example, embedded leases may be found in service contracts or other agreements that target specific physical assets that are exclusive to your company. Examples include a corporate box at a sports stadium, racks at a data center facility, or vehicles used by a transportation service. Your company needs to identify every such agreement and determine whether or not it contains a lease. If it does, the lease component must be extracted for lease accounting reporting.

As it stands now, accounting is making judgments about contracts without the expertise attorneys have in understanding contract language. That is why legal must know the ASC 842 legal implications and get involved in evaluating contracts and advising accounting about what should be considered a lease.

Learn more: Embedded Leases Accounting: Do Your Contracts Contain Leases?

#2 How to validate lease data and data collection plans

To protect your organization, legal must work together with accounting to make sure that lease information is accurately captured, summarized, and reported on. If you do not, you run the risk that auditors will not give and unqualified opinion and certify that your books are kept in accordance with GAAP.

To mitigate that risk, corporate attorneys should oversee (or at least approve) the data collection and validation process for lease accounting. You will need to understand:

  • The types of lease data needed for ASC 842 compliance
  • Tactical procedures for obtaining lease data
  • How to validate lease data so that lease accounting calculations and financial reports are accurate and complete

Learn more:

Data Collection Tips for ASC 842 Transition & IFRS 16 Compliance
Lease Data Validation Steps for FASB/IFRS Accounting & Reporting

#3 Sources of lease data

Who is providing the lease data that you are feeding into lease accounting systems and using to perform calculations for financial reports? You need to be very careful if it is coming from external service providers.

It is becoming more and more common for large organizations to outsource real estate services. In that case, much of your lease accounting data may be coming from thirty parties. How can you be sure that those service providers are following due diligence and providing accurate information? Legal may want to recommend the following:

  • Verification of lease data that comes from third parties (by comparing with original contracts, for example).
  • Make sure that contracts with outsourced service providers assign them some liability in case of errors.
  • Have outsourced service providers keep data in your own lease accounting system, rather than one that is under their control.

Learn more:

Why Real Estate Brokers Need Lease Accounting Software Solutions

ASC 842 legal implications: the silver lining for the legal team

Guiding your company through the lease accounting compliance process is going to prove time-consuming and complex. However, there is a benefit that your legal team can gain from this effort: a useful tool for managing corporate contracts.

Just about every organization with more than a handful of leases will need to purchase a tool to manage lease data and perform calculations. If you choose the right system, it can prove a significant asset to the legal team along with accounting, real estate and procurement.

Did we mention that Visual Lease was designed by lawyers? Moreover, that we use our own software to track and manage all our contracts (not only leases)?

We would be happy to show you how that works. Schedule a demo today to get started.

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