Why Organizations Should be Proactive About Changes to Lease Accounting Rules

13 Feb 2018

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) Topic 842 – Leases in an effort to improve financial reporting as it relates to leasing transactions. The main goal of the ASU is to increase transparency and comparability among organizations. This will be achieved by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information regarding leasing arrangements for leases with terms of more than twelve months. Past accounting rules stipulated that leases be accounted for as either operating (only expenses were recorded) or capital (assets and liabilities will be recorded) depending on various criteria. The new guidance anticipates creating a more faithful representation of an organization’s leasing activities for financial statement users. Topic 842 will impact any entity that enters into a lease; however, there are some specified scope exemptions.

Though this lease accounting update is not perplexing, implementation will require a great deal of work and effort, which by no means should be underestimated. Perhaps the greatest difficulty in implementation will be collecting the required data. Locating the various lease documents will undoubtedly present a challenge for organizations, especially if the documents are older and an effective filing system is lacking or doesn’t exist. Another issue may result from organization’s not possessing standard lease contracts (i.e. each lease contact containing different terms and formats to meet the demands of each lessor). This creates a challenge in merging the data to be reported in order to comply with the ASU. These issues will require organizations to allocate staff time, which may present further challenges as staff may be preoccupied with other accounting matters such as the recent revenue recognition update currently being implemented. One way to help smooth the transition required by this update is to review and ensure that the software (if any) used to manage leases is up-to-date and being used effectively. This ultimately may force organizations to purchase and implement new software or modify existing software to accommodate the changes.

With the challenges noted above, it is apparent and imperative to start a discussion and execute a plan of implementation as soon as possible. The effective date of 2019 for calendar-year public companies and 2020 for most other organizations is not as far away as it might sound. Please note that not-for-profits with conduit debt and certain employee benefit plans will have an effective date of 2019. Early adoption of the ASU is also permitted. The first step towards ensuring that a proper implementation plan is formulated is compiling the right team to take on the task. This likely requires an organization to have finance, IT, and real estate/property management individuals on-board. Other individuals that would aid in facilitating the process are those knowledgeable with procurement, treasury, and tax matters. Smaller organizations who may be unable to compile such a team, but possess a third-party bookkeeper, should really make certain that a clear understanding is established with the contractor responsible for aiding in the implementation of the ASU. Once the team or personnel are identified, the second step is to set a timeline and define who is accountable for each task. As mentioned earlier, the most difficult task involves locating all of the leases within the organization and as a result this should likely be of highest priority.

It may be possible that a lease contract cannot be located. If this occurs, the organization should reach out to the lessor directly or contact the lessors’ own auditors, who may have a copy of the contract on file. After locating all of the lease contracts, the organization can begin extracting the required data. For larger organizations, materiality may be a factor in having to discern which items are material or insignificant in terms of the scope of the new standard. After an organization has identified the leases that fall within the scope of the new standard, organizations should then analyze whether or not they can apply the portfolio approach, which will help expedite the transition process. The portfolio approach allows organizations to group similar leased assets into a portfolio to determine classification and measurement as long as the result is not materially different from applying the standard to individual contracts. In addition, a great deal of due diligence will be required to analyze and determine lease and non-lease segments of lease payments. Non-lease items that should be excluded include maintenance, taxes, and insurance. If these items are not clearly delineated in the lease payment, organizations should contact the lessor for an addendum that itemizes the various components of the lease payment.

The ASU does allow organizations to take a “modified retrospective transition approach,” meaning an organization can continue to account for leases that commence before the effective date in accordance with current generally accepted accounting principles (GAAP), unless the lease is modified. Lessees are required to recognize (on the balance sheet) lease assets and lease liabilities for operating leases at each reporting date based on the present value of the remaining minimum rental payments that were tracked and disclosed under current GAAP. Though this modified retrospective transition approach exists, it is still critical to be as proactive as possible with regard to the implementation of this new ASU. Individuals opting to wait until last minute may find the process taking longer than expected and those hiring third parties may be forced to pay a premium for the services.

As always, if you need help implementing the ever-changing accounting rules that face your business or nonprofit, reach out to your friends at Cerini & Associates for guidance.

Sean Wilkinson, CPA
Manager
Kaitlin Asam
Staff I Accountant