You know the drill. The FASB introduces a new code. Most companies procrastinate or hesitate to implement it. The changes go live. You make the necessary changes and ask yourself, “why did we wait so long to adopt the changes?” After ASC 606 left companies scrambling to update, the FASB made changes to the lease standard in ASC 842, requiring a new way of thinking and a new approach to accounting.

New Reporting—Without New Rules for Tax Accounting

ASC 842 is a demanding, complex, and labor intensive change. Though many companies received welcome news in the form of a one-year delay on account of a global pandemic, public companies are already starting to report under the new rules—and with new reporting means new tax considerations.

According to a recent article from Deloitte, anything that starts with GAAP quickly becomes steeped in tax. After all, a new way of accounting will require a new way of reporting, and a new way of reporting will require a change in the way taxes are calculated. But in this case, the challenge comes from a different look—a change in reporting without a change in the rules governing tax accounting.

“While US generally accepted accounting principles (GAAP) rules around lease accounting are changing, the rules governing tax accounting for leases are not. Whether a nonpublic entity preparing for implementation or a postadoption public entity facing this challenge on a business-as-usual basis, it’s crucial that an organization’s tax team adapts to new lease accounting systems and develops new processes to perform the same data extraction they did before the new standard.”

Three Challenges in Balancing Tax and GAAP under the New Lease Accounting Standards

Companies need to take the extra year they were gifted not only to update their lease accounting practices, but to rethink the way they deal with taxes. Those who do not involve their tax teams early will be left scrambling, and according to Deloitte, finance leadership will need to prepare for the following challenges:

Determining Deferred Tax Balances Specific to Right-of-Use Asset and Liability

Determining the deferred tax balances specific to the ROU asset and lease liability is unavoidable under the new lease accounting standard. The biggest surprise for many public companies was that their deferred tax asset and liability balances needed to be adjusted for the impact of the new requirements.

In turn, public companies have realized that they can’t use the book value of the ROU to record the new deferred balances.

Methods of Tax Accounting for Leases That May Be Impermissible

The change in how leases are accounted for under the new lease accounting standard is revealing impermissible methods of tax accounting for leases that need to be corrected going forward. For example, moving deferred rent, lease incentives, and prepaid rent into a single right-of-use asset will require a reevaluation of legacy lease treatment.

Incorporating New Lease Data into Tax Data

When applying the new lease accounting guidance, tax should also take the new data into consideration and determine if it warrants a corresponding change from the tax perspective.

A change in the definition of initial direct costs under the new lease accounting standard has pushed some companies to change the capitalization of these costs. Tax should evaluate if the new accounting treatment is permissible to follow or if the change in accounting results in a new book-tax difference.

Adapting to Changes: Discuss Your Lease Accounting Plans with Others

How is your company reacting to the new accounting processes involved with lease accounting? We and other controllers would love to hear from you. When you join the Controllers Council, you’ll gain access to the exclusive Controllers Council Community, the fastest-growing forum for finance professionals in the United States, where you’ll be able to understand the changing roles and find out ways to improve your outcomes. Learn more about becoming a member today!

Additional Resources

Complexities and Opportunities of ASC 842 Adoption

Using the Lease Accounting Deadline Extension to Your Advantage

New ESG Guidelines to Consolidate Standards and Reduce Confusion

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