Understanding M&A Lease Considerations
As companies contemplate mergers and acquisitions (M&A) as a means to accelerate growth and scale their business, they must consider how their lease portfolios, and that of their targets, will impact the deal integration. The timing gap created by the deadline extension for private companies to adopt the new lease accounting standard (ASC 842) raises important questions for adopters considering going into business with companies using the old standard as well as adherents of the old standard contemplating M&A with those who have already been through this process.
Identifying and engaging subject matter experts early in the process and having a team dedicated to lease integration is crucial.
Two of the most common challenges that arise during lease integration M&A activities are GAAP considerations and software selection and implementation. Addressing these challenges early and head on will ensure that a company is equipped to maximize the value and success of the overall transaction.
Pre-acquisition GAAP considerations
Strategic buyers or investors looking to acquire a private company that has not yet adopted ASC 842 should weigh the costs and benefits of the target company adopting the new standard before the acquisition takes place. For example, if the acquiree does not adopt ASC 842 before acquisition, then the acquirer cannot take advantage of the package of the practical expedients that exist to provide adoption relief. In this case, the acquirer must reevaluate each lease as if it were new.
By contrast, if the acquiree does adopt the new standard, the acquirer must still perform certain revaluation and remeasurement activities, such as recalculating the present value of the leases using the incremental borrowing rate (IBR) at the acquisition date. However, these activities will require significantly less effort to integrate the portfolio. For instance, the acquirer will be able to retain the acquiree’s lease classifications unless the lease is modified or the original classification was made in error. Additionally, the lease or non-lease component elections made by the acquirer can be maintained even if they do not align with the acquirer’s policy elections as long as the lease is not modified or the assessment was not made in error.
Except for the elections made by the acquiree, which fall under the package of practical expedients, the acquiree’s policy elections must align with that of its acquirer. For example, the approach to calculating present value (half-month vs. full-month convention) must match.
Post-acquisition GAAP considerations
The business combinations guidance (ASC 805) requires the acquirer to remeasure the acquiree’s lessee and lessor portfolio. The lessee portfolio should be remeasured at the acquisition date using the acquirer’s IBR. In certain instances, however, it may be more appropriate to remeasure leases using the acquiree’s IBR or a new IBR altogether. The appropriate IBR is dependent on how the acquiree will be integrated into the new company.
The lessor portfolio should be remeasured as the sum of present value of the lease receivable at the acquisition date using the implicit rate of the Acquirer’s IBR. Any leasehold improvements acquired should be amortized over the lessor of the useful life of the assets or the remaining lease term at the acquisition date.
ASC 805 provides remeasurement relief, which can be elected by the acquirer on an asset-class basis. The guidance allows the acquirer to not recognize any asset or liability (inclusive of intangibles) for leases with a remaining lease term of less than 12 months.
All operating leases (lessee and lessor) should be evaluated to determine if the contract contains an identifiable intangible asset or favorable or unfavorable lease terms compared with the market. Favorable/unfavorable lease terms should be recognized as an offset to the right of use asset (ROUA) for lessees and as either an intangible asset or liability for lessors. Identifiable intangible assets should be recognized as a separate intangible asset in accordance with ASC 805-20-25-10.
Lease management software selection
When choosing which leasing system to use, the acquirer will need to align its enterprise resource planning (ERP) strategy with its business objectives to find long-term synergies. This approach will allow the organization to determine its business needs and identify the right system to help achieve these goals. Companies should evaluate entity complexity, reporting capabilities, and the current ERP environment when choosing a leasing subledger.
When evaluating entity complexity, companies ought to consider the lease portfolio’s composition, whether asset types differ across portfolios, and if one system can handle the complete portfolio.
Reporting capabilities also need be evaluated, such as the availability of generic and custom reports and how easily data can be pulled for financial disclosures and management reporting requirements. Depending on the software selected, an acquirer may need to create manual workbooks to satisfy financial statement disclosure requirements.
Management also must assess integration with the current ERP ecosystem, such as if one system is a better fit for automated integration with the selected ERP. Otherwise, integration would require reloading all the leases from the old system into the new one.
Lease management software integration
Once the leasing software is chosen, the integration process can begin. The acquirer likely has a process in place and has identified pain points from its original ASC 842 adoption. Still, integrating the acquired company’s leases requires significant effort. One step in the integration process is to evaluate general ledger (GL) mapping and posting logic of the acquiree to determine which GL accounts are being used when recording lease transactions.
A second step in the integration process is the connection between the chosen leasing subledger and the general accounting ERP system. Depending on the leasing subledger chosen, the company will need to either develop an automated integration between the systems or a manual solution, such as pulling lease data into a bulk upload form. Adjusting entries will likely be needed to capture any differences in approach between systems.
A third step in this process is to map out a master data strategy to identify data elements that need to be consolidated or created. Both entities must have a single set of data related to their leases (locations, payment terms, asset codes, vendor codes) to successfully integrate the ERPs. For example, the two entities may both have leases with the same property owner but use different identifiers between the two systems.
Software integration best practices
When integrating an acquired business’s lease portfolio, one of the most important considerations is determining the right skill sets and resources to include on the integration team. Identifying and engaging subject matter experts early in the process and having a team dedicated to lease integration is crucial. With this in mind, management should consider whether to engage a third party to aid in the transition, which would allow the internal team to focus on the overall acquisition and integration. Lease adoption and integration experts are familiar with the process and know where common pitfalls may be, making execution much smoother.