Lease accounting processes are now required to comply with new Accounting Standards Update (ASU) under the FASB 842(US) and IFRS 16(European) standards. This would fundamentally change the lease accounting practices in ways not seen in decades. First to be impacted are public entities (starting 1/1/2019) and then all entities public and private (starting 1/1/2020). They will be required to change the accounting for 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? Do they all appear on your depreciation schedule? What kind of resources and systems are available to help you? How best to manage the compliance process?
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 external auditors and consultants. 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 well 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 the 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.
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. Using the proper technology to manage the leases and to capitalize them is key 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 (ROU) 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. Axxerion provides a comprehensive and easy-to-use lease management system. It has a built-in ‘wizard’ for easy creation of the capitalization tables. The system supports different strategies offered by FASB ASC-842 and IFRS-16 such as ‘Full retrospective” and “Practical expedient”. Axxerion also manages the lease options and include them into the calculations following the requirements of the standards.
About the author
Mehdi Khalvati, Ph.D. is the president of Axxerion Inc. Axxerion’s Contract Lifecycle module addresses creation, management, notification, finances and approvals for leases and contracts. For more information, please review the contract lifecycle management page. Please send your feedback, thoughts and comments to firstname.lastname@example.org.