A Major Change To Lease Accounting – What are My Options?

By: John Weller as originally posted in Billboard Insider

If you were to look at the Lamar Advertising 2020 Annual Report, the balance sheet lists a long term asset titled “Operating lease right of use assets” in the amount of $1.22 Billion.  On the other side of the balance sheet there is a related liability, in the same amount, titled “Operating lease liability”, split between short term and long term in the same amount.  That amount is there because, effective 2019, Lamar and other publicly traded companies adopted a new method of accounting for operating leases known as ASC 842 .

What does this have to do with my business and why would I want to look at the link for ASC 842?

For many companies, there is not much need other than idle curiosity.  However, if you are an owner or manager of an outdoor business that has reached a size where, as a financing requirement, an annual independent audit or review is required, you need to appreciate the impact of this new accounting requirement.

There is a significant time and cost investment associated with ASC 842. That includes, in most cases, installation of additional software that tracks and evaluates every lease in the company portfolio.

We spoke with a large regional outdoor company who has been reviewing the steps involved with compliance .  Their existing operating software system  did not have the capability to meet the requirements of the new standard (yours probably will not either). There are software providers that have the capabilities to evaluate and provide lease compliance (examples are LeaseQuery or Power Plan).  For this outdoor company, along with the time and cost investment of integrating into a new system, the annual cost of the software platform would be $500,000!

If an owner/operator had $500,000 in available cash,  you would want to invest that capital into building value through sign construction or acquisition, not into the accounting department (my apologies to CFO’s reading this).  Knowing this, Billboard Insider approached a retired Partner in Charge of a large regional CPA firm with expertise in this matter and sympathy to the operating concerns of an owner of manager.  Here is what we learned.

The accounting and reporting for long term leases, especially for a small to intermediate sized non-public company, is almost always a complex and onerous process.  And the information presented – specifically the grossing up of long-term assets and liabilities with capitalized leases – can result in bloated balance sheets that are arguably difficult to understand.

In my experience, keeping the accounting simple – recording all leases as operating leases no matter what – keeps the primary financial statements more meaningful for most operators AND lenders.  The problem is doing so likely puts the reporting entity at odds with Generally Accepted Accounting Principles (GAAP).

I have 3 basic recommendations – all 3 strongly suggested as a package deal – to make this a mostly defensible reality:

  • Move away from traditional GAAP statements to OCBOA (Other Comprehensive Basis of Accounting). CPA’s can write unqualified opinions on OCBOA statements.  A company may define its OCBOA as “modified accrual with all leases treated as operating leases”.  This is NOT “pick and choose” accounting that can change from transaction to transaction or year to year.
  • DESCRIBE AND DISCLOSE. Meaning commit to doing ALL GAAP disclosures in your financial statement notes, especially for leases. Tell the reader exactly what you’ve done.  The more disclosure the better.
  • Meet with your lender and other users of your financial statements. This will be a nonstarter if your lender absolutely requires GAAP statements.  Negotiate the language of your lending documents – specifically covenants – to allow for your OCBOA reporting.

A quick summary from Insider, if you are audited and want to implement this strategy:

  • First determine who your audience is.  In most cases it will be your bank, who is requiring the audit.
  • Talk to your CPA about ASC 842.  Understand, with them, your full costs of compliance and, assuming you want to avoid  the costs and time, work together in approaching your bank with a combined strategy.
  • Have a conversation with your bank explaining what you propose and what it will mean to your audit report.  Our experience is bankers like accurate, understandable financial statements that accurately reflect your business operations.  ACS 842 does not accomplish that goal, in fact it will make your balance sheet much more confusing. They also like available cash to be invested in growing your business which provides additional comfort in your ability to meet your debt commitments.  Help them understand the cost to the company to be compliant with ACS 842.

If you have already been looking into ASC 542 and want to pass along your thoughts, feel free to reach out to me at [email protected].