Private companies: Evaluate lease contracts once – for cost savings and ASC 842 compliance

Observations from the front lines

Background

Dealing with the challenges of the global pandemic has unleashed waves of universal business changes. Many companies are taking a hard look at operating models and opportunities to cut costs, adapting to new ways of working and creating flexibility to respond to changing market conditions. This has often meant digging into contracts to see which could be modified, terminated or—in some cases—expanded or renegotiated. 

The detailed work on contracts is directly relevant to the work needed to adopt the new lease accounting standard (ASC 842), giving private companies an opportunity to factor ASC 842 into these broader efforts. 

In the hunt for savings and efficiency, you’re likely to look at the same contracts that you will have to review again when you adopt ASC 842. Combining those efforts may mean a bit more work upfront but lets you take a “once and done” approach to evaluating leases.

Evaluating leases

Potential operational and cost improvement opportunities

You may currently be assessing operations, speaking with vendors and lessors, and developing contingency plans to minimize the impact of disruptions from the ongoing COVID-19 crisis. Leased assets are always a good place to look for savings and efficiency. They are also natural steps to take when adopting the new leasing standard.

Take stock of your existing leasing footprint

Real estate footprint

How does your existing space align with your return-to-the-office strategy? Will social distancing require more space? Does it make sense to concentrate people in one location or many? Does it even make sense for all your employees to come to work every day?

Equipment portfolio

Is existing equipment appropriate for more employees working remotely?

Short-term considerations

Are there enough laptops, VPN access, etc., to support a more remote working model? Can your systems accommodate a larger population of users without sacrificing security or speed? What if employees lack high-speed internet because of where they live? As companies right-size their real estate footprint to reduce/contain cost and provide greater flexibility, does it make sense to consider shifting their traditional corporate long-term office strategy to shorter-term flexible offices where they can rent desks, offices or conference rooms?

Long-term considerations

How can you be ready for whatever comes next? Are you ready for another lockdown if it comes?

Gather and use leasing data to pinpoint cost- reduction opportunities

  • Are you paying too much in common area maintenance and other charges? Does it make sense to exercise audit rights to right-size charges?
  • Do your leases include unused incentives or other allowances?
  • Some leases initially require a security deposit or escrow, but provide for their return under certain circumstances. Are you entitled to money back?

Establish or refine your lease-versus-buy strategy

Assessing your lease portfolio and the related terms will provide the data needed to establish standards for making better leasing decisions going forward, including: 

  • Do the costs of leasing outweigh the benefits of buying equipment outright after considering the cost of capital? Depending on the answers to the questions below, you may need to negotiate new agreements:

    • Is it time to consolidate vendors? What incentives might they offer and how does that compare to switching costs and those offered by existing vendors?

    • What about leases that have ended during the pandemic? They often shift to month to month leases which may not be as economical as replacing or returning them. 

    • Is near-term cash flow an issue? If so, how can you tackle that with lessors and revamp your real estate and equipment portfolio to meet your near-term and long-term strategy?

Additional considerations

From copiers to cafeteria appliances, operational needs may now differ immensely from the previous status quo. For ongoing leases, check for force majeure clauses – the pandemic may excuse performance, depending how the clause is drafted. When leases are due for renewal, try renegotiating the embedded interest rate in equipment leases or consolidate vendors for a given asset.

Consider building a cross-functional team that sets a realistic budget and concurrently  troubleshoots  both operational and accounting implications. Key players may include finance, IT, tax, procurement, treasury, audit, and real estate and facilities. An integrated operational and accounting initiative can create efficiencies across departments and regions.

In summary

Private companies may benefit if they go beyond the bare minimum needed for ASC 842 compliance. Consider the lease accounting transition as a broader business transformation that includes both lease cost containment and ASC 842 compliance concurrently — Once and done!

Leasing cost containment

How PwC can help

Our team offers private companies deep, integrated lease accounting, tax and operational expertise. We can help evaluate and analyze a wide range of lease accounting solutions to enable compliance, accuracy, savings, process automation and operational efficiencies. We look forward to discussing how we can help you navigate ASC 842 adoption and emerge stronger.

“Observations from the front lines” provides PwC’s insight on current economic issues, our perspective regarding the financial reporting complexities, and what companies should be thinking about to effectively address those issues. For more information, visit www.pwc.com/us/cmaas.

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C.J. Finn

Partner, Private Company Services, PwC US

Brandon Campbell Jr.

Managing Director, PwC Deals Practice, PwC US

Katherine Huh

Advisory Real Estate Director, PwC US

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