NetLease - Transition to ASC 842 Overview

Transition Method

With the adoption of ASC 842 in full swing, NetLease is here to make the transition easier.

One important decision as you input leases into NetLease is determining the lease commencement date that will be used.

Recalculate historical amortization from inception of lease:

NetLease will generate amortization schedules from the beginning of lease's life.

Pros:

Retain reporting flexibility and a full history of the amortization schedule of each lease since inception
Don't have to deal with deferred rent balances as of the commencement date

Cons:

Setup prone to human error and more time consuming to set up as every modification and lease amendment since inception will have to be entered via a pre-go live modification
Errors can be tedious and difficult to undo for pre-go-live modifications
Possible transition adjustment if historical amortization amounts don't tie out perfectly

Under this method the following rules apply to the lease upload:

Commencement date = original commencement date for each lease
Lease term = full term of lease from inception date to end date
Discount rate = rate at inception date
Prepaid lease payment, initial direct costs, lease incentives = balance as of original commencement date
ROU adjustment (usually where we account for deferred rent when adopting ASC 842) = 0

Recalculate historical amortization as of the most recent modification prior to the adoption date:

NetLease will take into account existing accumulated amortization and amortize the remaining ROU asset over the remaining lease term.

Pros:

Pre-go-live modifications are not necessary
Still allows for some historical schedule information to be generated

Cons:

Need to know the deferred rent balance as of the date of the modification as this will impact ROU asset calculation

Under this method the following rules apply to the lease upload:

Commencement date = date of most recent modification
Lease term = updated to only include remaining periods in lease term
Discount rate = rate at commencement date (date of most recent modification)
Prepaid lease payment, initial direct costs, lease incentives = balance as of the modification
ROU adjustment (usually where we account for deferred rent when adopting ASC 842) = balance as of the date of the modification

Recalculate historical amortization as of the ASC 842 adoption date:

NetLease will take into account existing accumulated amortization and amortize the remaining ROU asset over the remaining lease term. This is our recommended option.

Pros:

No messy historical modifications and amendments to keep track of
Simplifies data validation

Cons:

No view of historical amortization amounts in NetLease subledger
Need to know deferred rent balance as of the adoption date as this will impact your ROU asset

Under this method the following rules apply to the lease upload:

Commencement date = adoption date
Lease term = updated to only include remaining periods in lease term
Discount rate = rate at commencement date (adoption date)
Prepaid lease payment, initial direct costs, lease incentives = balance as of the adoption date
ROU adjustment (usually where we account for deferred rent when adopting ASC 842) = balance as of the adoption date

The next decision will be determining how leases have been accounted for in the past so you can correctly make the transition to ASC 842. Companies previously used either cash basis accounting or ASC 840.

Transition Cash Basis to ASC 842

Companies that previously used their lease cash payment as the lease expense each period employed what is known as cash basis accounting. In order to transition to ASC 842 from cash basis, there are two methods that can be employed.

Method 1: Cash Basis Cumulative Catch-Up Method

Under this method, companies will generate the lease schedule from inception under ASC 842 to calculate the deferred rent balance period over period. Companies will use this schedule to identify the deferred rent balance as of the lease commencement date and enter that deferred rent balance into NetLease via the "ROU adjustment" field on the lease record. The deferred rent balance will impact the ROU Asset and is therefore a vital input into getting the accounting right under ASC 842. Once entered into the system, NetLease will calculate the appropriate amortization schedule and lease expense going forward.

Initially, NetLease will book the following entry when going live:

Debit: ROU Asset

Credit: ROU Accumulated Amortization

Credit: Lease Liability

Debit/Credit: Clearing Account

A manual entry will then be required to zero out the clearing account.

Credit/Debit: Clearing Account

Debit/Credit: Expense/Retained Earnings

NOTE: The clearing account balance contains a cumulative difference over all the years - current and prior. You will need to calculate which years the differences occurred to determine the breakdown between current year expense and retained earnings. Alternatively, you can elect to include the full difference in expense in the current year.

Pro of this method:

Lease expense is correct from the lease commencement onward

Con of this method:

Potential for a large adjusting entry to expense or retained earnings at the ASC 842 adoption date

Method 2: Cash Basis to ASC 842 with no Adjustment

Under this method, companies assume that historical lease accounting was done correctly. Leases are entered with the adoption date as the commencement date, no deferred rent is used, and the lease is basically started from that point onward as if it was new (with an updated useful life for the remaining term).

Initially, NetLease will book the following entry when going live:

Debit: ROU Asset

Credit: Lease Liability

Debit/Credit: Clearing Account

A manual entry will then be required to zero out the clearing account.

Credit/Debit: Clearing Account

Debit/Credit: Expense

NOTE: The clearing account balance is for the current year only and as such should impact expense and not retained earnings.

Pros of this method:

No adjusting entries needed
Easy and quic

Cons of this method:

Lease expense is wrong
Doesn't take into account deferred rent

Transition ASC 840 to ASC 842

Companies that previously used ASC 840 for lease accounting will need to transition to ASC 842. The key to this transition is to get the deferred rent balance correct as of the lease commencement date and input that deferred rent balance into NetLease via the "ROU adjustment" field on the lease record. The deferred rent balance will impact the ROU Asset and is therefore a vital input into getting the accounting right under ASC 842. Once entered into the system, NetLease will calculate the appropriate ASC 842 amortization schedule and lease expense going forward.

One item to note, lease expense is the same under ASC 840 and ASC 842, so companies need only to put on the balance sheet impacts of ASC 842 operating leases and clear out the deferred rent balance from ASC 840 operating leases in the transition.

NetLease will book the following entries for each lease when going live:

Debit: ROU Asset
Credit: ROU Accumulated Amortization at go-live date
Credit: Lease Liability
Debit/Credit: Go-live clearing account

Customer should manually book the following entry for each 840 Financing Lease:

Credit: ROU Asset
Debit: ROU Accumulated Amortization at go-live date
Debit: Lease Liability
Credit/Debit: Go-live clearing account

Customer should book the following entry for each 840 Operating Lease:

Debit/Credit: Deferred Rent
Credit/Debit: Go-live clearing account

Together these entries net to zero (or small transition adjustment amount). If the recalculate historical amortization method is used, the small transition adjustment should be written off as of the go-live date.

Opening Periods vs Current Month Adjustment

Often the question arises if all the periods in the adoption year need to be opened, lease entries reversed out, and lease entries rebooked under ASC 842. Assuming the company has been accounting for leases correctly in the past, just not under ASC 842, we recommend not opening periods. However, that is up to the companies discretion as they know their accounting practices and needs best.

Opening Periods:

Pros to opening periods:

NetLease will book all the lease entries based on the lease schedule
Can use GL reports as well as subledger reports for reporting functionalities

Cons to opening periods:

Need to reverse out all lease journal entries that have been booked in the year
Still have to manually clear out the deferred rent balance as of the adoption date
Messy and room for errors in prior periods that were once closed

Current period adjustment:

Pros to current period adjustment:

Subledger reporting functionality relies on schedule lines and not journal entries, so you can still utilize those reports
Don't have to open closed periods
NetLease will calculate a cumulative go-live entry to take into account amortization booked in prior periods
Easies

Cons to the current period adjustmemt

Still have to manually clear out the deferred rent balance as of the adoption date

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