Under ASC 840, companies used the balance sheet account called deferred rent to enable straight-line rent expense. The deferred rent account is where companies held cash paid for rent that did not equal the average rent required by ASC 840. Under ASC 842, the account is not needed. However, the concept presently remains in place presently.
Deferred Rent v. ROU Asset
FASB retained the concept of straight-line rent expense for operating leases. This is the major difference between ASC 842 and the IASB’s version of the leasing standard, IFRS 16. Therefore the mechanics that FASB prescribed in ASC 842 are much more complicated than ASC 840. However, the net balance sheet and rent expense impact of leasing remain largely the same. Now, instead of deferred rent, we have right of use (ROU) asset and lease liability accounts. The net activity in these two accounts will be the same as deferred rent under ASC 840 for the same lease as long as all variables remain constant. The complexity of moving from a relatively simple process of straight-line under ASC 840 to the more complicated process involving multiple accounts and net present value (NPV) calculations under ASC 842 has undeniably motivated most companies to consider a lease accounting software solution.
Adjusting the ROU Asset
The lease liability of any lease set up under ASC 842 is based unequivocally on the NPV of future payments. The ROU asset is based on the same value even though adjustments are occasionally required. Upon transition to ASC 842 there is generally a deferred rent balance on the books for ASC 840. Adjusting the opening ROU asset by that amount is actually the only way to ensure the straight-line or level lease cost remains unchanged when transitioning. Otherwise, companies have to go back to lease inception and re-abstract years of data just to achieve compliance. This is unnecessary and can represent a massive drain on time and resources allocated to the compliance effort. True enterprise class lease accounting solutions offer an automated process. This allows for seamless transition from ASC 840 to ASC 842 guidelines, without the requirement to re-abstract old data.
When evaluating lease accounting solutions, keep deferred rent transitions at top of mind. Make sure ROU asset adjustment functionality is in place and easy to use. And know that many similar issues like this will come up when transitioning to new lease accounting guidelines. However, companies that take a proven path with a true enterprise class lease accounting solution have experience and expertise on their side. CoStar has helped hundreds of clients implement a solution to manage lease administration and lease accounting for equipment and real estate. Is your team interested in finding a solution with CoStar Real Estate Manager? Reach out today for a demo.