Skip to Content
Professionals working at laptop

Lease accounting: Take advantage of the ASC 842 delay to avoid debt covenant violations

September 19, 2019 / 4 min read

ASC 842’s changes to lease accounting could put your company in violation of debt covenants. We look at how a proactive response can help you avoid problems when the new rules go into effect.

Private companies may be breathing a little easier after the Financial Accounting Standards Board (FASB) proposed to delay the effective date of ASC 842, Leases, until 2021. But it’s important to resist the temptation to put off preparations for the new standard: ASC 842 will have a significant impact on balance sheets, potentially resulting in debt covenant violations and increased investor scrutiny. Instead, companies should take advantage of the extra time to adopt the new rules, understand their impact on the business and its financial reporting, and have proactive conversations with lenders, investors, and others before issues arise.

ASC 842 in brief

ASC 842 requires companies to recognize all finance and operating lease assets and liabilities on the balance sheet. Before the new rules, companies kept operating leases off the balance sheet, a practice that meant some companies might be underestimating their liabilities — significantly so, in some cases. According to FASB, ASC 842 will provide much more transparency for investors around leases and related liabilities. As the new standard requires operating leases to be recorded on the balance sheet, it’s expected that more emphasis will be placed on identifying and recording leases that are included in contracts that aren’t traditionally called leases (i.e. embedded leases). Some examples of these may be service contracts where a vendor provides the use of an assets for little or no cost as an incentive for the organization to enter into the contract.

Companies could find themselves in violation of debt covenants — or trying to explain why return on assets has suddenly dropped.

Much more than an accounting change

While ASC 842 will require significant accounting work, it will also have a considerable impact on financial statements. Some estimates suggest the new rules will have a material impact on the balance sheet of 80% of companies, with trillions landing on public companies’ balance sheets this year alone. It will also result in new assets appearing on balance sheets, as companies begin tracking the “right of use asset” for their leased items.

These new balance sheet items will likely change multiple key financial ratios, from debt-to-earnings to return on assets. In some cases, companies could find themselves in violation of debt covenants — or trying to explain why return on assets has suddenly dropped.

It’s not enough to extrapolate from a representative sample of leases: you’ll need to find them all.

The good news is that banks have known for some time that ASC 842 was coming. Lenders understand that the company’s business hasn’t fundamentally changed overnight, but companies should discuss the new rules’ impact with them. The same goes for investors who may not be as current on emerging accounting changes and therefore require companies to explain what’s happening and why. And the earlier these conversations happen, the better.

Don’t wait: Act today on ASC 842

FASB’s proposed ASC 842 delay doesn’t mean you should put preparations for the new rules on the back burner. Instead, be proactive. You and your team need to take action to understand what ASC 842 means to your company — and get started on the significant work involved.

ASC 842 may be delayed for private companies, but it’s still coming — and preparing for the change represents a significant investment of time and effort. Starting the work today will enable you to identify and mitigate the impact of the new rules on your balance sheet and debt obligations, and minimize the risk of lender-related issues after the rules go into effect. If you have any questions, please give us a call.

Related Thinking

Image of woman in office reading papers in a three ring binder.
December 21, 2017

New lease standard: What you need to know right now

Article 9 min read
Woman writing in binder
January 20, 2021

Lease accounting roadmap: A detailed tool for implementing ASC Topic 842

White Paper 15 min read
Staff meeting discussing culture change
December 18, 2017

Will new revenue and leasing standards change the way you do business?

7 min read