The Impact of ASC 842 on Budgeting and Planning

Last Updated on March 1, 2024 by Morgan Beard

Lease accounting has undergone significant changes over the years, with the Financial Accounting Standards Board (FASB) issuing a new set of accounting standards in 2016 known as ASC 842. This new lease accounting standard replaced the existing ASC 840, and with it came a host of changes that impact budgeting and planning for companies.

The impact of ASC 842 on budgeting and planning cannot be overstated. The new leasing standard requires companies to report their operating leases as assets and liabilities on their balance sheets, which means that companies need to reassess their budgeting and planning strategies to account for the updated rules in lease accounting. In this blog post, we will discuss the impact of ASC 842 on budgeting and planning and provide some transition guidance and practical tips for organizations.

What is ASC 842?

ASC 842 are the new lease accounting rules issued by the FASB in 2016 that requires companies to report their operating and finance leases as ROU assets and liabilities on their balance sheets. Under the previous standard, ASC 840, companies were only required to report their capital leases as assets and liabilities on their balance sheets. This meant that many operating leases were off-balance sheet, which made it difficult for investors and analysts to assess a company’s financial position accurately. With this change financial statement users will have more transparency into an organizations financial statements and the overall health of their asset and liabilities associated with their lease portfolio.

The new rules require companies to recognize the present value calculation of lease payments as a lease liability on their balance sheet, with the corresponding right-of-use asset recognized separately. This change means that companies need to reassess their budgeting and planning strategies in accordance of the generally accepted accounting principles, GAAP.  The impact of ASC 842 varies depending on factors such as the size of your lease portfolio and the type of your business, whether it is a non-profit, private, or public company.

Impact of ASC 842 on budgeting and planning

The impact of Accounting Standards Codification, ASC 842 on budgeting and planning is significant, primarily because companies must now recognize their operating leases as assets and liabilities on their balance sheets. This change affects several areas of budgeting and planning, including:

Financial statements

The new standard requires companies to adjust their financial statements to reflect the new lease accounting standards. This adjustment may require companies to restate prior financial statements, which can impact budgeting and planning for future periods. These are important changes that are stated in the accounting guidance that affect the income statement and balance sheet.

1. Balance Sheet: ASC 842 requires recognizing operating leases as right-of-use assets and corresponding liabilities, increasing total assets and liabilities on the balance sheet. This change affects financial ratios, influencing how stakeholders assess the organization’s financial health.
2. Income Statement: ASC 842 introduces a distinction between lease expense recognition for operating and finance leases. Operating lease expenses are replaced with depreciation on the right-of-use asset and interest expense on the lease liability, impacting the organization’s operating income.
3. Cash Flow Statement: ASC 842 changes lease payment classification on the cash flow statement, affecting operating and financing activities. Previously, operating lease payments were classified as operating cash flows, but now, payments are split into principal (financing cash flows) and interest (operating cash flows). This improves insight into cash flow dynamics related to leasing and financing.
4. Disclosure Requirements: Additional qualitative and quantitative disclosures are required in the financial statements, including information about lease arrangements and significant leasing judgments. Companies must also provide comprehensive accounting policy elections related to ASC 842 implementation, which involve choices made in areas such as lease classification (finance vs. operating), discount rates, initial direct costs, and practical expedients utilized during the transition.
5. Financial Ratios: The changes to the balance sheet and income statement may affect financial ratios such as debt-to-equity ratio, leverage ratios, and asset turnover ratios, impacting how investors and stakeholders assess the organization’s financial health and performance.

Capital expenditures

ASC 842 impacts an organization’s capital expenditures by reclassifying operating lease payments as financing activities instead of operating expenses. This change reduces the portion of lease payments that would have been recognized as capital expenditures under the previous lease accounting standard (ASC 840). As a result, reported capital expenditures may decrease, leading to potentially improved capital efficiency and a different allocation of expenses on the financial statements.

Lease management

ASC 842 significantly impacts an organization’s lease management processes by necessitating a comprehensive and detailed record-keeping system. Companies must now meticulously document lease terms, payment schedules, and renewal options to comply with the new standard. This shift in lease management practices can have profound effects on budgeting and financial planning, as accurate and up-to-date lease information becomes critical for forecasting lease expenses and making informed decisions about leasing arrangements. Moreover, the increased transparency and scrutiny in lease reporting under ASC 842 may require organizations to implement robust lease management software or systems to effectively track and manage their lease portfolio.

Practical tips for managing the impact of ASC 842 on budgeting 

1. Start early: Companies should start planning for the implementation of ASC 842 well in advance to ensure that they have enough time to assess the impact on budgeting and planning. 
2. Review lease agreements: Companies should review their existing capital lease and operating lease agreements to determine the impact of the new standard on lease payments, lease terms, and lease options. This review can help companies assess the impact of the new standard on budgeting and planning. Companies should look out for embedded leases to make sure there isn’t an identifiable asset that has payment obligations and has an economic benefit to the company. 
3. Use technology: Companies should consider using software solutions to manage their leases, which can help streamline lease management processes and improve budgeting and planning. With a thorough review, a cloud based software with data collection will have all the required information in order to assist.  
4. Communicate with stakeholders: Companies should communicate with stakeholders, including investors, lenders, CPA Firms, Accounting staff and analysts, about the impact of ASC 842 on budgeting and planning. This communication can help manage expectations and ensure that stakeholders are aware of any potential impacts.

The Impact of ASC 842 on Budgeting 

The overall impact of ASC 842 on budgeting and planning is significant, particularly from a lessee’s perspective. The introduction of ROU assets and lease liabilities, along with changes in lease expense recognition (e.g., straight-line expense), requires careful evaluation of financial statements, cash flow forecasting, and capital expenditures. To successfully manage this accounting change, companies should proactively plan, review lease agreements, leverage technology solutions, and engage in effective communication with stakeholders.

Despite the challenges, ASC 842 implementation offers several benefits. The standard enhances transparency and accuracy in financial reporting, fostering trust and confidence among stakeholders. Furthermore, it presents an opportunity for companies to identify potential cost-saving measures by reevaluating lease vs. buy decisions.

In conclusion, companies cannot overlook the impact of ASC 842 on budgeting and planning. By adopting practical strategies and focusing on the advantages of the new standard, organizations can navigate the transition effectively and emerge with stronger, more transparent financial reporting practices.