Lease Accounting 101 â€“ The Ins and Outs of ASC 842 & IFRS 16
New standards for reporting the financial impact of leases will require public companies to change their accounting practices by the end of 2019 and private companies to do so by the end of 2020. That might seem like a minor consideration at first, but most companies lease some assets. The transition can be tricky and the impact on balance sheets promises to be significant.
Today, the SEC estimates more than $2 trillion in lease-related expenditures and liabilities were left off balance sheets in 2018. The implosions of Enron, Tyco and WorldCom in the early 2000s inspired the new standards. Each of those companies used leasing agreements to hide massive financial and operating liabilities, and each used its distorted balance sheets to misrepresent its strength to auditors and investors while committing serious financial crimes whose exposure drove them out of business and many of their executives into prison.
FASB and international standards agencies jointly developed the new standards; as ASC 842 in the U.S. and IFRS 16 internationally, the standards are largely identical and address the same goal: getting lease information back onto companiesâ€™ balance sheets.
This represents a huge change for just about every accountant working today: The old standards were first adopted in 1966 and last revised in 1976. Chris Miller, a distinguished solution specialist and one of Oracle NetSuiteâ€™s experts on the new leasing standards, put together a hugely informative hour-long webinar to walk us through the changes and what they mean in practical terms for companies of all sizes.
The webinar is well worth a full viewing, but for now, here are three key takeaways:
Lease Accounting Has Impacts Beyond the Balance Sheet
Meeting the new standards will do more than affect the sort of balance-sheet information published in the annual report. It will require the participation of companiesâ€™ tax experts and real estate departments to supply needed data and IT to render it. Speaking of IT, most ERP systems arenâ€™t prepared for the demands of ASC 842, so new software might be necessary. (More on that later.)
Bringing new liabilities onto the balance sheet also makes reporting more complex and may have broader financial and legal implications. Companies will want to review their debt covenants with banks, to ensure that key ratios arenâ€™t thrown suddenly into dangerous territory. And all contracts should be reviewed for the presence of embedded leases, which merges with the new revenue recognition standard.
Get Your Implementation Plan Together Now
Miller walks viewers through a comprehensive lease-accounting framework that details the specific changes to journal entries and formal balance sheets. Each leaseâ€™s discount rate figures heavily here: Companies have a bit of leeway in how they value the asset underlying each lease, and the resulting discount rate can affect a companyâ€™s reported leverage, interest cover, asset turnover and operating profits/earnings.
Miller also works through Day one and Day two accounting measures, demonstrating how lease liability and right-of-use asset calculations combine to present a complete picture of a companyâ€™s lease obligations.
Make Sure That Your Software Meets the Challenge
Some of the new standardsâ€™ demands can be met using a combination of legacy software and hard work. Others simply canâ€™t. The disclosure requirements imposed by the new standards, for example, result in simple demonstrations of a companyâ€™s future obligations and the operating leverage represented by its leases, but those simple expressions draw on such a complex array of data that most existing systems simply canâ€™t be made to provide expedient answers.
Excel might be enough to do the trick, at companies with solid programmers on hand. More readymade solutions exist in products like NetSuite Fixed Assets and third-party solutions built on the NetSuite platform, such as NetLease by Netgain.
In any event, the new standards require a wide-ranging responseâ€”Miller offers a six-point transition planâ€”backed by software thatâ€™s up to the job. If youâ€™re interested in learning more, please click hereÂ to view our on-demand webinar, Lease Accounting 101 â€“ A Roadmap to ASC 842 & IFRS 16.