Lease Accounting Standards- Ready for a Dramatic Change?
Posted by Christopher L. Miller, CPA, MBA, CMA, CITP || Distinguished Solution Specialist
With all the discussion and preparation of the new lease accounting standards, ASC 842/IFRS 16, the time has arrived for public companies to begin reporting their results. However, as we saw with ASC 606 last year, many companies have underestimated the effort and time required to comply with the new standards. KPMG has recently completed a study that found most companies are way behind in their lease accounting projects, but there is still time to get on track.
The new lease standard, known as ASC 842 or IFRS16, represents a joint effort of the FASB and international standard setters to create a unified standard for leasing activity. While some notable differences exist, there are several key features that all companies who have leased assets will need to understand. Those changes are:
- Lessees will recognize all leases, including operating leases, with a term greater than 12 months on-balance sheet.
- Key balance sheet measures and ratios may change, IT systems may need to be upgraded or modified, and accounting processes and/or internal controls will need to be revised.
- Lessees can choose between two transition methods, with additional practical expedients available.
- Sale-leaseback accounting is substantially changed.
- Both qualitative and quantitative disclosures are expanded.
Despite past experience with ASC 606 and the sweeping changes ASC 842 represents, many companies are still unprepared. According to the KPMG survey:
- Only 3% of respondents said their lease project was complete.
- Among those still working on their projects, 67% said that they were not on schedule due to the challenges they were facing.
- Only 44% had identified their leases and just 25% had assessed the accounting impact of ASC 842 and/or IFRS 16 on their business.
- 45% of companies believe they have software that can manage the process, but only 16% have developed the requirements necessary for implementation.
You may find yourself in a similar situation with lease accounting as you did with ASC 606. Whether that implementation went long, or the dates arrived sooner than expected, now is the time take action. For private companies, there is still a runway to complete projects on time and on schedule.
There are many ways to successfully transition to the new standard. The difference between them is often how long and how much will it cost? There are three vital steps to turning around your leasing setbacks.
First, make sure you have conducted an accounting impact assessment on how the standard will affect you. Many respondents have compared lease accounting to revenue recognition for its complexity and scope.
Second, resource the team correctly. Complying with lease accounting is a cross functional effort, even though it is concentrated in the accounting team for the final compliance results. For example, you can enlist the real estate team, office managers, etc. to help you find leases that require abstracting.
Lastly, address the four core challenges to implementation:
Identifying Embedded Leases
- Review all of your service contracts for embedded leases. Anywhere equipment or space is being allocated, there could be a lease.
- Look at your intercompany agreements to see if any of your allocations are in fact embedded leases.
Establishing an Appropriate Incremental Borrowing Rate (IBR)
- If possible, take advantage of the expedients with respect to simplifying your IBR.
- Conduct an analysis based on each asset to determine the appropriate rate. Remember, IBR is not the same for all assets, even in the same class.
Abstracting & Entering Leases into a System
- Collect all of the documents that show the four key data elements: the commencement date, the end date, the payment and the interest rate. These are the bare minimum requirements to construct a lease for the new standards.
- When selecting software, have a checklist of your companyâ€™s functional needs and focus on what you need for disclosures and existing business practices.
Integrating a Lease Accounting System into the Existing Environment
- NetSuite offers a limited use lease feature in its Fixed Asset Module.
- For NetSuite customers that need a complete lease accounting solution there are certified platform applications, such as NetLease fully compliant on the Lessor/Lessee side.
- Take advantage of prebuilt connectors if a 3rd party solution is necessary. These would include CoStar, Visual Lease, and Trirega.
Lease accounting is a big project, especially after finishing revenue recognition last year. If you begin looking for the right software, compile your records, and conduct the proper accounting impact, your team will be ready for the new standards.
Â Want to learn how you compare to your peers, when it comes to preparing for the new Lease Accounting standards? Take this short survey to help determine where pain points exist as well as how the new standard will affect business priorities.