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    The Complete Guide to the New Lease Accounting Standard

    We've created this resource center to help keep you informed and up to date with helpful information about the new FASB and IASB leasing standards.


Introduction and Quick Links

After years of discussion and a host of draft documents, in January of 2016 the Financial Accounting Standards Board and the International Accounting Standards Board each released new mandates related to accounting for leases.  While companies have always had to disclose their lease data, they’ve generally done so only in the footnotes to their financial statements. The new lease accounting rules will move lease information to the balance sheet. The Wall Street journal predicts that this will increase the stated liabilities of public companies by at least $1.5 trillion.

 

lease accounting standards resource centerQuick Links:

Background

Key Facts About the New Standards

Frequently Asked Questions

Steps to Compliance

Implementation Risks and Warnings

Technology Considerations

Resources

 

Background

Off-balance sheet accounting for leases has been a subject of controversy since the late 1990’s. In 2005, the SEC identified reporting for leases as something that needed a new approach. FASB and International Accounting Standards Board (IASB) set out to address it. In 2010, the Boards began considering significant changes to the way leased assets are reported by companies.

They issued a proposal that moves all lease agreements (other than leases less than 12 months) onto the balance sheet. All leases will be considered “right-to-use” assets and a lease liability to make future payments.  The new mandate gives potential investors a more accurate view of the company’s assets (right-to-use) and liabilities (lease payments and obligations).

Leasing is an important source of finance to business. Therefore, it is important that lease accounting provides users of financial statements with a complete and understandable picture of an entity’s leasing activities.”

-FASB Discussion Paper

The Boards issued two exposure drafts, the first in 2010 and a second in 2013. Following the release of the drafts, the Boards undertook extensive outreach including fieldwork meetings where members of the Boards and staff visited financial statement preparers, both public and nonpublic, lessees and lessors.

After years of rumors of an imminent announcement, on January 26, 2017, the boards released the new standards -  FASB ASC 842 and IFRS 16.

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Key Facts About the New Lease Accounting Standards 

 
FASB lease accounting standards deadlineImplementation Date

For public companies, the new FASB mandate applies to financial statements for reporting periods after December 15, 2018. For private companies, the rules apply to reporting periods following December 15, 2019.

The implementation date for IASB is January 1, 2019. The GASB (Government Accounting Standards Board) standards changes apply to reporting periods that begin after December 15, 2018.

*Note: It was initially assumed that companies would have to provide two years of look back financials, essentially making compliance required for public companies in 2017. However, late in November 2017, FASB issued a proposal to eliminate the lookback requirement. A final decision has not yet been announced. We will update this page when more information is available.

 

FASB Lease Classification

FASB has retained a two-part classification for leases – finance and operating.

Leases are considered finance type if:

  • The lease automatically transfers ownership of the property to the lessee by the end of the lease
  • The lease contains a bargain purchase option
  • The lease term is for a major part of the estimated economic life of the property
  • Payments represent substantially all of the fair value of the asset
  • ROU will be amortized separately on the Income Statement from interest expense
  • The fair value and economic life test are expected to be similar to the 90% and 75% tests under existing GAAP guidance.

All other leases would be considered Operating Type Leases.

 

IASB and GASB Lease Classification

The IASB and GASB have decided to account for all leases more than 12 months as finance type leases.

 

Lease Types

Real estate agreements are an obvious form of lease financing for companies, but other lease types are included in the mandate as well. Equipment leases, vehicle leases, embedded leases, and master leases of more than 12 months must all be considered.

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Frequently Asked Questions

 
Lease accounting FAQsWhich companies will be impacted by this change?

All public and private companies will be required to follow the new standards, but those with many leased assets will see the biggest impact. Although real estate leases are often the largest line item, companies may have many more equipment, technology, vehicle and other lease contracts. Organizations in the retail, health care, financial services, and telecommunications services, for example tend to have relatively large real estate lese expenses that will need to be capitalized. But even businesses without leased real estate will need to address the new standards.

 

Will the new standards change lease negotiation, administration, or other business practices?

Yes. Many companies will view the standards change as an opportunity to review and update leasing practices from stem to stern. In some cases, the new standards will impact the buy vs. lease decision. Lease negotiators may want to move away from gross leases to those that call out service rent and other charges that don’t need to be capitalized. The practice of lease administration will come under more scrutiny by auditors and financial managers than ever before, so new levels of review and audit trails will likely be implemented.

 When should companies start working to comply with the new standard?

The short answer is right now. According to the Journal of Accountancy, “Almost one-fourth (23%) of companies surveyed in May 2017 by PwC and commercial real estate services firm CBRE said they hadn't started their lease accounting adoption efforts yet. And a Deloitte survey showed that 31.4% of more than 2,150 executives polled in May 2017 said their organizations were unprepared to comply with the new standard.” That means there’s a lot of work left.

 

What are the potential consequences of non-compliance?

The SEC’s Division of Corporate Finance selectively reviews filings made under the Securities Act of 1933 and the Securities Exchange Act of 1934 to monitor and enhance compliance with applicable disclosure and accounting requirements.

If a public company is selected, the cost associated with the following should deter companies from misstating their financials:

  • Lawsuits from investors for the misstated financial statements
  • Cost of bringing in fraud examiners to investigate (if it is determined that fraud was involved)
  • Cost of responding to an SEC Comment letters
  • Bring in big 4 consultants to restate prior years
  • Stock price taking a big hit due to the restatement
  • Auditors getting fined for the misstated financial statements

 

Do all private companies have until 2020 to comply?

Compliance with the new standard is required for private companies starting with reporting periods that begin after December 15, 2019 (meaning 2020 for organizations that operate on a calendar year basis). However, private companies with public debt, such as many hospital systems may be compelled to report based on the time frame for public companies. If you are unsure, please consult your CPA or audit firm.

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Steps to Compliance

Every organization will need to develop its own project plan, but there is a basic path that most will follow.

 
Steps to FASB lease accounting complianceAssemble the Project Team

A smooth transition will require a cross-functional team working together to cover all aspects of compliance. The corporate finance and real estate teams will ultimately do much of the heavy lifting when it comes to preparing for and complying with the new FASB standards; but it is an effort that spans multiple departments and functions.

The IT staff will often be involved in the process to implement controls over relevant lease data that is needed to comply with the new standards, as well as controls related to judgments, estimates, and management reviews.

Procurement and facilities teams will also be involved because non-real estate leases such as office and manufacturing equipment will be included in the new calculations.

Investor relations, PR and legal professionals will also need to be informed about the impact of the new lease accounting standards on the balance sheet. HR also needs to be involved, as the company may need to ramp up staffing or redeploy existing personnel to meet project deadlines. Executive compensation tied to financial performance may also need additional review and potential revision.

 

Develop a Project Budget

Most organizations will need to make additional technology, services and/or human resources investments in order to comply with FASB 842 or IFRS 16. A key component of compliance will involve IT spending. The vast majority (92 percent) of respondents from The Great Accounting Challenge: KPMG’s 2016 Accounting Change Survey believe they will need to upgrade their IT system or invest in new technology because of the new lease accounting guidelines. In addition, 77 percent say that technology represent the most challenging part of compliance.

In addition to the technology, companies will need to budget for implementation, training, and post-installation follow-up.

 

Get Prepared – Find the Leases

Many organizations have a management system of some sort or real estate leases, but equipment and other lease contracts may be scattered throughout the organization. The first step to compliance is identifying every lease and assessing the accuracy of lease data in existing systems.

There is a wide range of data that is needed from any lease agreement in force for 12 months or longer in order to make the correct classification and complete the calculations. Some information is not commonly abstracted into lease accounting systems today, so organizations will need to determine if internal resources or a professional services partner will do this abstraction.

 
Choose the Right Technology

We’ll cover this more in-depth in the lease accounting compliance technology section of this page, but in most cases, existing technology will not be sufficient to support the new standards. Some companies will need an entirely new lease administration solution, while others will need to purchase additional software from current vendors. In either case, the decision should be made early in the process so that data acquisition and implementation can begin quickly.

 

Evaluate Lease Negotiation and Approval Practices

Certain lease terms may be more advantages to organizations under the new standards. For example, some leases include service rent, which does not have to be included in the capitalization schedule, but don’t say exactly how much of the gross rent is service rent. Leasing teams may want to request more clearly defined lease terms in the future and may even want to renegotiate existing agreements. As we mentioned, the practice of leasing will receive greater attention and audit review, so approval requirements and internal audit plans may need to be revised.

 

Think Beyond Compliance

Smart finance and real estate professionals see the new standards as a strategic opportunity to optimize lease accounting practices. Centralizing lease agreements provides the opportunity to use the consolidated lease data, improve capital project management, streamline operational maintenance, and optimize space planning, among other areas.

Preparing to comply with the new FASB standards is also the perfect time to revisit the organization’s overall approach to lease management.

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Implementation Risks and Warnings

New lease accounting risks

With Microsoft as an exception, not many companies have chosen to implement the new leasing standards early. However, many are far along the path to compliance. Those we’ve worked with have pointed to a few unexpected risks and challenges. Here are the potential points of failure to consider.

 

Collecting the Real Estate Data

Some organizations have relied on the assumption that because they have software for managing real estate leases, they were prepared for compliance. What they failed to realize is that much of the information required for a correct lease classification is not usually abstracted from the lease today. In addition, much of the required information, like the net present value of the asset, or borrowing rates isn’t in the lease at all. The bottom line is that collecting, and auditing required lease data is likely a bigger challenge than expected. Getting to work on it soon is essential.

 

Equipment and Other Lease Types

Real estate leases may represent the highest dollar value, but often equipment and other leases far out number them. They are less likely to be centrally managed if they are even tracked in a system at all. In some cases, many department level managers can approve non-real estate leases, and each may be operating under a different set of controls. Enough time should be allotted to evaluating non-real estate leases and putting systems in place to administer them in alignment with the compliance requirements.

 

Cross-Functional Collaboration and Process Management

Because the road to compliance runs through a variety of different functions, organizations must take great care to engage in information sharing and involve the right subject matter experts. The most successful organizations define each role carefully and set up internal communications plans to keep everyone informed and on task.

 

Time

The clock is ticking. There is less than a year left to achieve compliance for public companies and private companies with public debt. Those who haven’t started yet have cause for concern. In addition to the strain that waiting until the last minute will put on internal resources, finance leaders should be aware that software vendors and professional services firms will be stretched thin as the deadline approaches.

 

Ongoing Compliance

Compliance with the new lease accounting standards is not a one-time event. Finance teams should review all ongoing leasing practices in order to minimize the balance sheet impact and make continued compliance seamless.

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Technology Considerations

Choosing the best solution to support your lease accounting compliance efforts is the key to a successful transition. Each of the following capabilities and solution attributes should be considered.

 

Lease accounting standards technology
Is the FASB/IASB compliance functionality integrated with lease administration?

Some vendors are offering a bolt-on FASB calculator that sits between the lease administration system and the accounting solution or ERP. This is a high-risk approach because many day-to-day leasing activities will trigger a schedule reassessment. For example, exercising a renewal, accepting tenant improvement allowances, or any change to rent payments will require a schedule revision. Since these activities are managed in the lease administration solution, and integrated compliance and management approach makes the most sense.

 

Has the solution been evaluated by CPA firms and financial reporting experts?

Compliance with the new leasing standards is complex and there are many opportunities for incorrect calculations. The best vendors have partnered with CPA firms to ensure accurate calculations and the appropriate application of the rules.

 

Will the solution support all lease types?

Most organizations will need support for both real estate and equipment leases. Embedded leases and master leases are also common and should be considered. In addition to the asset type, look for a solution that supports both lessees and lessors. Even if you aren’t a landlord today, you may want to sublease space at some point, so it pays to invest in a solution that can handle this and other complex leasing scenarios.

 

Is there an audit trail?

It will be increasingly important to know who made changes to lease data and why. You’ll also want a record of when transactions are posted and by whom.

 

Will the system easily integrate with your accounting or ERP solution?

Once the lease administration solution makes the correct calculations for the capitalization schedule, it will need to send the appropriate journal entries to your accounting or ERP system.

 

Does the solution provide adequate security?

Security has always been an important lease accounting consideration, but new mandates make it even more of a concern. Consider only vendors that conduct SSAE 16 audits, and offer three-factor authentication to ensure that your system is accessed by only those authorized to do so.

 

Can the vendor provide a range of implementation services?

You may not know from the beginning how much help you will need implementing your new technology and getting ready to comply with the new standard. Most vendors will provide technical implementation services, but the best partners also have a team that can help with lease abstraction, data migration, and operational consulting.

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Resources


AMTdirect is the recognized leader in FASB and IFRS lease accounting solutions. We recognize the formidable challenge finance, real estate, and equipment leasing face as they work to comply with the new, far more complex standards (FASB 842 and IFRS 16). Here you will find valuable resources for charting your path to compliance. Check back frequently for updates.

 

 


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