The search for the “new normal” in lease accounting
ASC 842, the new lease accounting standard, represents the most significant change in decades in the way companies account for leases under US GAAP. For the first time, companies are required to present most of their operating leases on the balance sheet, which has resulted in a sharp increase in liability balances in the financial statements of many organizations.
Although the new standard is not yet in effect for private companies, public companies have already adopted the new rules, and many have entered their second and third years under the new accounting. Add to this the economic turmoil caused by the coronavirus pandemic, many companies (especially those in sectors heavily dependent on rental) have been motivated to take a closer look at their lease portfolios and the impacts on their operations.
The adoption of the new lease accounting standard has had an impact on all companies with operating leases in their business model. However, some industries have experienced a greater increase in their liability balances than others due to the nature of their business and services. As seen in the recent LeaseQuery article Rental responsibility index report, several key sectors have been significantly affected by the new standard, including higher education, catering and retail. These same industries have also been directly affected by the global pandemic, which has changed their markets and the way they serve their customers. Companies in these sectors have likely thought about new strategies and innovations to respond to recent economic tensions and leasing decisions are a critical area that these types of companies can tap into.
The higher education sector has seen an increase of over 7,000% in liability balances due to ASC 842 and the requirement to present operating leases on the balance sheet. This industry also had to react immediately to the coronavirus pandemic with flexibility and swift action to maintain services in a new environment marked by social distancing. Colleges and universities have switched to a virtual learning model almost overnight. While online courses have been an option for many years now, the shift to a fully virtual environment has had lasting effects on the education industry and what students will expect in the future.
Even after social distancing and COVID restrictions are eased, virtual learning is a format that will remain in greater demand than ever. As more students seek to achieve their higher education goals through online courses, colleges and universities should expect a corresponding decrease in on-campus services such as accommodation and food. .
Higher education institutions now need to critically review their business model and operations to determine whether strategic decisions need to be made to better position themselves to reap the benefits of a more hybrid educational environment. For example, some colleges and universities might find savings opportunities by reducing their real estate footprint due to the decrease in activity on campus. On the other hand, the need for more technology to serve their stakeholders could mean that some institutions will rely on more technology assets in the future and new decisions regarding the purchase or lease of these assets will be. taken.
The restaurant industry was another environment that felt the immediate impact of the pandemic. Government restrictions on businesses along with society’s increased focus on social distancing and health concerns have meant that many restaurants have faced a drastic decrease in consumer activity. In many cases, this has resulted in closures and downsizing for some businesses.
Conversely, the sudden shift to online ordering and delivery services has created new opportunities for these businesses. Many consumers were participating in food delivery services for the first time out of necessity, but the convenience gained through these options translates into continued demand for them in the future.
The restaurant industry has a historically active rental environment, with many on-site restaurants managed through operating leases. As a result, not only has this industry seen an immediate impact on its balance sheet due to the adoption of the new rental standard (an average increase in liability of 41x), but it has also encountered new rental decisions due to of its response to changing consumer behavior. forced by the pandemic.
Increased demand for delivery options means catering businesses may consider reducing the size and number of on-site spaces needed to serve their customers. However, with improvements in food and safety standards and procedures, these same businesses may also need new equipment, which will result in more leases in the future.
Given the new lease accounting standard and the coronavirus pandemic, the retail industry has also seen significant changes. This industry has long relied on operating leases, with many retail stores leasing storefront space in malls and shopping centers comprising a variety of retail stores. Operating leases entered into by retail companies often include a payment structure based on business performance, as owners structure their leases to include payments based on the percentage of sales.
When the pandemic struck, many retail businesses struggled to stay operating and profitable given the shelter-in-place and self-quarantine proclamations. These companies were locked into operating leases that they had to continue to pay despite the fact that their financial performance was affected by reduced sales to consumers. As a result, 54% of retailers said they requested rent concessions to help manage the impact of the pandemic. Other retail companies have faced situations of abandonment and renegotiation of leases as their need for retail space changed.
Benefits beyond compliance
The effects of the new ASC 842 lease accounting rules and the economic changes due to the pandemic have had a lasting impact on businesses and the way they manage their operations and finances. While adopting ASC 842 is a time-consuming task, there are benefits to having a deeper understanding of an organization’s rental business. Adherence to the new lease accounting standards has prompted many companies to centralize and improve their lease data, making them better prepared to make beneficial leasing and sourcing decisions in the future.
In addition, by having more data, companies negatively affected by the pandemic have been able to respond more quickly and successfully to economic challenges by identifying opportunities to renegotiate leases, apply for rent concessions or modify their strategies. procurement and cost savings. Lease accounting software solutions help businesses simplify new accounting requirements and manage and analyze their rental business. Arming accountants with the best technology – one that offers reporting functionality that makes it easier and faster to access information and data analysis – can make the difference in making the right strategic decisions for the post-pandemic economy.