New Lease Accounting Standards Curfew December 31… Do You Know Where Your Balance Sheet Is?
Lease accounting to comply with new Accounting Standards Update (ASU) under FASB 842(US) and IFRS 16(European) is about to change in fundamental ways not seen in decades. First to be impacted are public entities (1/1/2019) and then all entities public and private (1/1/2020) impacting leased assets such as buildings, vehicles, furniture and fixtures, office equipment, rolling stock, aircraft and manufacturing equipment to name a few.
Who in your or any organization has a definitive list of all leased assets? What about the lease documents and terms and the fair value of the assets? They do not appear on your depreciation schedule. Who do you turn to? Legal? Accounting? Supply chain? IT? Production? Packaging?
As with most daunting tasks the starting point is to develop a plan, including policies and procedures, and an implementation team. Make sure that team includes the external auditors. They are not only the experts, but they are the ones whose time and cost will be incurred in testing your lease accounting, so you might as get it right up front.
Under the new standards, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months. Consistent with current Generally Accepted Accounting Principles (GAAP), the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP—which requires only capital leases to be recognized on the balance sheet—the new ASU will require both types of leases to be recognized on the balance sheet.
There are significant consequences (unintended or otherwise) that will flow from this new standard not the least of which is the impact adding these liabilities to the balance sheet with have on financial statement ratios and loan covenants.
The ASU also will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements.
Lessor (those that own and lease assets to lessees) accounting remains largely unchanged.
Using the proper technology to manage the leases and to capitalize them is a key step for successful compliance with the standards. It is important to have a central database of leases with the proper and easy access for the responsible persons. The lease management application needs to provide a step by step and easy process to qualify a lease as operating and finance leases. Standards allow reducing the rent to be capitalized by the amounts such as landlord allowance, initial direct cost and impairments.
The system would need to organize the lease amounts by classifying the ‘fixed rent’ and other expense types. Once the amounts are totaled the system needs to generate the capitalization table by calculating a Right Of Use asset and amortizing it over the life of the lease. The standard allows deploying different strategies for selecting the starting point of the capitalization. The capitalization table needs to have all the GL entries over the life of the lease. It should also be exportable to Excel and other financial systems.
Leases start with certain negotiated terms and then may be modified or renegotiated as things change. This includes, expansions and reductions, unplanned increases and options as well as early terminations. Each of such events would require a restatement of the lease capitalization with the proper values.
Under these new standards lease management and accounting has become exponentially more complex. Specialized software to support compliance and proper accounting will be essential and should provide a comprehensive and easy-to-use lease management system. Further, it should be able to create the capitalization tables under the various strategies offered by FASB ASC-842 and IFRS-16 such as ‘Full retrospective” and “Practical expedient”. Finally, an effective software will manage the lease options and include them into the calculations following the requirements of the standards.
Joe Markunas, CPA is a Partner at CFOS2GO and leads their Life Sciences and Healthcare practice group which is dedicated to serving the financial, consulting as well as interim and permanent staffing needs for companies in these and other industries. Additionally, Joe has conducted successful accounting and consulting engagements for clients in industries as diverse as manufacturing, ecommerce, agri-business and import/export to name a few.