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Lease Accounting Compliance: Does Your Company Need to Comply?

Definition of FM-1

Do the new lease accounting standards apply to your company? In almost every case, the short answer to that question will be yes. The long answer involves taking a closer look at your contracts.

But, first, exactly which new leasing standards are we talking about? There are three standard-setting accounting boards: the International Accounting Standards Board (IASB), the Governmental Accounting Standards Board (GASB), and the Financial Accounting Standards Board (FASB). Each develops guidance on financial reporting for specific types of entities.

Which standard you need to comply with depends on what type of organization you are. Entities with leasing activities that fall under more than one board’s jurisdiction, will need to report according to the guidelines set forth by each board concerned. 

Lease accounting compliance and international companies

Companies that have international leases report under the guidance of IFRS 16, Leases, which replaces the earlier IASB leasing standard, IAS 17. The effective date of IFRS was January 1, 2019. 

Governmental organizations

Institutions of higher education and governmental entities need to comply with GASB  Statement No. 87, Leases. Its effective date has been postponed one year due to the COVID-19 crisis.

Public and private U.S. companies

Public and private companies and nonprofits who follow U.S. GAAP report under FASB Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), more widely known as FASB ASC 842. For public companies, the effective date has come and gone. 

Private companies and private nonprofits benefit from yet another deadline deferral--this one also delayed by the global pandemic. That date is now effective for fiscal years beginning after December 15, 2021. 

Background on the new lease accounting standards

The corporate scandals of the early 2000s prompted the SEC, U.S. Congress and the three accounting boards to investigate accounting practices that inadvertently allowed for misrepresentation in a reporting entity’s financial statements. 

The regulators found an off-balance sheet operating lease loophole, and that discovery set in motion a wave of accounting reforms. Congress passed the Sarbanes-Oxley (SOX) Act, and all three standard-setting boards issued new lease accounting guidance to ensure an entity’s financial statements would be more transparent and reflect a more accurate picture of its financial health.

Despite some differences between the new guidance set forth by FASB, IASB and GASB, the most sweeping change made by all three is the requirement to recognize operating leases on the balance sheet. 

Previously, operating leases were disclosed only in the footnotes section of a company’s financial statements. 

ASC 842 and private U.S. companies

Nationwide, there are more than 6 million private companies, and the reality is most will need to comply with the new FASB standards regarding lease accounting. 

To determine whether you fall into this vast group that needs to join the journey to compliance right now, begin with identifying whether you have entered into any leases or contracts with terms of 12 months or more. While you’re examining your contracts, keep in mind that the word lease doesn’t have to appear in a contract for a lease to exist.

According to FASB ASC 842, a lease must meet the following criteria:

  1. Identified asset. There must be an identified asset which is physically distinct or if that’s not the case, the lessee should be able to receive substantially all of the capacity of the asset.
  2. Economic benefit. Lessees should receive substantially all of the economic benefit from the right to use the asset.
  3. Control use. The lessee should have the right to determine the use of the identified asset.

A common misconception is that if you have only a few leases or if you don’t have any real estate leases, you’re exempt from compliance. However, that is not the case. FASB’s new lease accounting standards apply to any U.S. business that enters into a lease that meets the term criteria--whether it’s just one lease for a piece of equipment or a comprehensive portfolio of real estate leases.

During this analysis phase, be on the lookout for embedded leases. These are typically found in service contracts--for office equipment, transportation arrangements, IT services, manufacturing agreements--which contain provisions for the right to use an asset and meet the definition of a lease.

Since companies have not been required to account for these “hidden” leases under the legacy guidance, locating them presents a new challenge for lessees. As part of your implementation process, your accounting department will need to create new processes and controls for efficiently identifying and tracking this kind of lease.

The consequences of non-compliance

With only a handful of leases, whether they are real estate, vehicles, equipment or embedded, it may be tempting to focus on other business priorities and forgo adopting the new lease accounting standards altogether or by the deadline.

Companies who choose this route could face serious consequences for partial compliance or non-compliance, including fines and the need for filing a financial restatement. Although no one likes to pay fines, the latter has far-reaching repercussions.

First, you may see your business suffer from a drop in its valuation which could be critical if you are planning to sell or take your company public. As a result of a decrease in your valuation,, your company’s credit rating could be lowered, negatively impacting your ability to obtain favorable lending. One adverse effect leads to another.

Conclusion: Simplify compliance with an automated solution

In an effort to make financial reporting more comparable, transparent and accurate, all  three accounting boards released new lease accounting standards. Although there are differences in the standards, including effective dates, all share a significant change--moving operating leases to the balance sheet.

For international companies and U.S. publicly traded companies, the new guidance is now in effect. Governmental entities and private companies in the U.S. have been granted more time for implementation of the new FASB standards.

If you’ve been delaying the implementation process because you were unsure whether or not you needed to comply with the new lease accounting standards or simply because the task seemed daunting, it’s time you faced the fact that compliance isn’t optional. 

Still having doubts about your specific situation and compliance? Take our quick (less than 3 minutes) Risk Assessment. You’ll start by answering a few questions about your business and finish knowing where you stand.

By starting implementation now, following a detailed timeline and utilizing lease accounting software to ease the burden, you’ll find compliance doesn’t have to be complicated.

The team here at AMTdirect is uniquely qualified to help you through the implementation process. We have over 20 years of experience in lease administration and lease accounting, so you can trust our friendly expertise. 

And if you’re considering using automated lease accounting software to make the transition to the new lease accounting standards more efficient, accurate and stress-free, ask to see our demo. Our solution has already helped hundreds of other companies successfully achieve compliance.

Schedule a Demo Today!

Posted on 4/27/20 11:19 PM by The Team at AMTdirect in FASB, in Lease Accounting

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