Lease Accounting Effective Date Delay: How Oil and Gas Companies Can Leverage Lessons Learned

The Financial Accounting Standards Board (FASB) recently approved a delay in the effective date of the new leasing standard (ASC 842) for private companies. The standard will now become effective on January 1, 2021, giving private companies an additional 12 months to carefully plan and execute their adoption of the new guidance.

Capturing completeness is a significant challenge

Many public oil and gas companies said the greatest challenge of adopting ASC 842 was accurately capturing a complete population of leases and gathering the necessary data required to make accurate lease assessments. This challenge was due to the ‘just-in-time’ nature of oil and gas operations. Under the old lease guidance, companies were not required to capitalize operating leases, meaning many arrangements were not assessed in detail nor segregated into specific accounts or financial statement line items. As a result, knowing exactly where to look for leases posed a significant challenge for most companies.

Completeness is also one of the biggest areas of focus for external auditors. Companies were required to perform extensive procedures and prepare detailed documentation outlining how they were able to obtain comfort that they identified a complete population of leases during the adoption of ASC 842. In addition to the challenge of identifying all potential leases, obtaining the contractual support necessary to assess the arrangements under ASC 842 also introduced difficulties for oil and gas companies. Many of the contractual arrangements subject to potential lease implications are typically executed by operations and field personnel. Between the just-in-time nature of the industry and the frequency of agreements executed at the field level, locating the applicable support and identifying the appropriate operational employees with knowledge of the leasing arrangements was frequently more time-consuming and complex than originally expected.

Diversity in practice exists for similar asset classes

As public oil and gas companies continue to refine and improve disclosures related to the adoption and application of ASC 842, financial statement users are noting different conclusions being reached for similar asset classes across the industry. Unique contractual terms coupled with the overall subjectivity introduced by the new standard have led to diversity in lease portfolios. Each entity must rely on the assessment of the specific terms and conditions of their contracts to make decisions related to certain key lease criteria such as the length of the non-cancellable lease term and whether an identifiable asset exists. Additionally, diversity in conclusions have been reached related to certain significant asset categories such as hydraulic fracturing equipment, drilling rigs, and compressors.

Given this diversity in practice, private companies will not be able to rely solely on the conclusions disclosed by public oil and gas companies; rather, these companies will need to perform their own independent assessments and determinations for each specific contract.

Lease portfolios will likely change under the new guidance

Oil and gas companies frequently depend on service providers to execute various upstream, midstream, and downstream activities, often requiring the use of highly specialized assets. The change in the definition of a lease under ASC 842 means that many types of service arrangements may contain an embedded lease. Simply put, an embedded lease arises when a company determines it controls the use of the assets even though the service company might be physically operating the asset. These types of arrangements were typically not assessed for potential lease implications under the old lease guidance.

The oil and gas industry is also a rental-heavy industry. Traditionally, many rental arrangements were assumed to be operating leases and not tracked in great detail. The specific terms and conditions of rental arrangements may require that certain operating leases historically expensed as incurred now must be capitalized on the balance sheet or tracked for short-term lease expense disclosures. Depending on the size and complexity of a company’s lease portfolio, collecting and abstracting this data could require significant time and resources.

Act now

Many public oil and gas companies faced significant challenges when adopting ASC 842: the time, resources, and investment to successfully adopt exceeded initial expectations. Similarly, private companies will need to devote significant time and effort to achieve a successful adoption of the new standard. The FASB’s decision to delay the adoption date of the new lease guidance provides private companies with the opportunity to leverage lessons learned during public adoptions so that they can begin to strategically plan and execute their adoption projects.