For years, many businesses kept lease obligations off their balance sheets, particularly operating leases for office space, equipment, and vehicles. But with the introduction of ASC 842, those days are over.
Originally impacting public companies in 2019, private businesses are now required to comply with the new lease standard. While some private business owners may assume this rule only applies to large corporations, ASC 842 affects any company that follows GAAP and has lease agreements longer than 12 months.
1. Your Financial Statements Will Look Different
Under ASC 842, businesses must report most leases as both assets and liabilities, rather than just listing them in the footnotes of financial statements. This change can significantly impact key financial ratios that lenders and investors rely on.
For example, adding lease liabilities to the balance sheet could increase the debt-to-equity ratio, making a business appear more leveraged. If a company has loan agreements with debt covenants, failing to monitor this change could put it at risk of breaching those terms.
2. Lenders and Investors Are Paying Attention
Even if a company is not publicly traded, lenders and investors still want transparent, accurate financials. Whether applying for a business loan or seeking private investment, financial institutions will analyze lease obligations differently under ASC 842.
What does this mean for private businesses?
- Loan terms may need to be renegotiated if lease liabilities impact financial ratios.
- Potential investors will now have a clearer picture of long-term financial commitments.
- Auditors will expect proper classification and disclosure of lease agreements in compliance with the new standard.
3. Lease vs. Buy Decisions Could Change
With leases now appearing as liabilities on the balance sheet, some businesses may reconsider whether leasing or purchasing assets is the better financial strategy.
For example, if a business leases expensive equipment or office space, buying the asset outright may provide better financial flexibility. Business owners should analyze the impact of these new liabilities and determine if leasing is still the best option.
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4. Cash Flow and Budgeting Require a Closer Look
ASC 842 does not change the actual lease payments, but it does change how lease costs appear on financial statements. That means business owners need to factor these adjustments into cash flow projections and budgeting to avoid surprises.
Now is a great time to:
- Review existing lease agreements to ensure they are properly classified.
- Assess financial ratios to determine how lease liabilities impact debt levels.
- Work with an accountant to ensure compliance and minimize risks.
5. Planning for Growth, Sale, or Succession
For businesses considering a sale, acquisition, or succession planning, the way lease liabilities are reported can impact overall business valuation.
Whether preparing for an eventual sale or transitioning ownership, ASC 842 compliance ensures that financial statements accurately reflect a company’s position, giving buyers, investors, or successors confidence in the financials.
How to Stay Compliant and Plan for the Future
Private companies that have not already adopted ASC 842 must take action now to remain compliant and avoid financial misstatements.
Here’s what businesses should do next:
- Identify all lease agreements and determine how they should be classified under ASC 842.
- Adjust financial statements to include right-of-use (ROU) assets and lease liabilities.
- Review loan agreements and debt covenants to ensure compliance.
- Work with a CPA or accounting expert to navigate these changes smoothly.
At Whittaker CPAs, we specialize in helping businesses understand and adapt to financial reporting changes like ASC 842. If you need guidance on lease accounting and how it impacts your financial strategy, contact us today.
