New Lease Accounting Standard

Nidhi , Last updated: 29 May 2017  

The new ASU (Accounting Standards Update) for Leases (Topic 842) under USGAAP has been issued by FASB. For public companies, the ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Thus, for a calendar-year company, it would be effective January 1, 2019. The primary objective of new lease standards is to ensure that companies worldwide capitalize operating leases and include them on their balance sheets as assets and liabilities for the purpose of giving users of financial statements information on operating lease obligations that they typically estimate for their particular analytical purposes.

When these rules take into effect, the most of the US based public companies will need to show comparable balance sheet for at least one year prior and P&L statements for two or three years for SEC purposes.

The new rules will impact to some extent to almost all entities with lease contracts but the lessees will likely have significant impact as the companies as Lessees will be have recognize all of their leases (over 12 months period) on the balance sheet. The present value of the operating lease payments will be recorded as a separate asset and liability and the P&L expense will remain as the straight line average rent expense.

Under the current rules, operating leases are accounted for off-balance sheet and a table of future operating lease obligations are disclosed in the footnotes to the company’s financial statements.

For sure the impact of capitalizing leases is significant as it puts new assets and liabilities on the balance sheet, though the impact on profitability for many companies is not significantly different from the existing standards to the new standards. And this change calls for major work and planning by Finance teams with substantial increase in administrative burden as they would have to review and analyze each and every lease contract in the organization and ensure compliance to new standard.

For the multinational companies with multiple business lines it requires collaboration across different department with a central PMO team to create a detailed project plan for data gathering, data analysis, identifying and implementing an appropriate technology solution integrated with accounting systems & ensuring disclosure requirements in financial statements along with tax implications if any. 

To meet the compliances, most of the companies have:

(1) Formed a project team with representatives of all departments involved in the leasing process (including Finance/Treasury, Lease Administration, IT, Accounting, and the Business Units);

(2) Initiated process to become familiar with the requirements of the new lease accounting standards usually with Lease SME expert consultant on board; and

(3) Started creating a plan to develop processes, systems, and controls that will record all necessary data required for compliance

(4) Started analyzing impact of any financial ratios since lease assets and liability would appear on balance sheet though operating lease obligations would be classified as non-debt other liabilities.

During the transition process, all existing operating leases are being identified, documents read, lease payments extracted, gross/bundled billed payments separated, payments and terms input into system.

Some of the important points to ensure during this process are:

  • Since the data to calculate payments comes from several sources in the organization, it is important to ensure completeness of data by engaging all relevant teams.
  • Non-lease components in gross or bundled billed payments must be separated as per the new rules. Most of the building rent agreement include electricity & other facility charges which need to segregated for accounting purposes.
  • To compute the present value of the asset and liability, the source for discount rate has to be identified for each market where lease asset exists and it will have to be ensured that those rates meet US GAAP standards requirement.
  • For lease assets on balance sheet, there will be requirement for annual impartment testing for which data sources need to be identified and model created for testing as per US GAAP standards.
  • Considering the complexities involved around data maintenance and analysis it would be good to have robust technology solution to support new standard requirements which is auditable, automated and scalable.
  • While designing the solution, it is important to ensure that reports required for financial disclosures including SEC-required comparable are available as an output. Footnote information requirements of estimated payments included in lease payments for future periods (next 5 years and a thereafter). The FASB also requires the disclosure of the weighted average lease term and the weighted average discount rate used to capitalize the leases.
  • The external auditors and regulators need to be periodically consulted before finalizing the proposed process.
  • The governance mechanism for timely and accurate lease data especially any changes in terms or period etc has to be created especially for companies with multiple locations.
  • Ensure to have a process in place that on each accounting reporting date, assumptions for variable rent are reviewed with the finance department along with renewal assumptions (whether there has been a change in determination regarding bargain renewals) and with the Operations department.
  • With respect to the periodic journal entries to be booked, it will be important to review existing chart of accounts and the proposed designed accounts are identified. A balance sheet entry must be made recording an asset called “the right to use leased assets” and a liability called 'capitalized lease obligation.'
  •  The tax team needs to be consulted and involved or any tax implications including deferred tax accounting impact.
  • Further, multinational companies that may have local reporting needs will have to keep records for both FASB and IASB for capitalized operating leases.

So, in summary there is a substantial planning going behind the scenes in the companies to ensure that they are ready to meet the complex compliance requirements under new lease standard. Throughout the process, it will be important to pay attention to feedback from actions already taken and involve all the relevant stakeholders in process design. The transition process to the new lease accounting Standard will include the robust planning process and the creation of new processes and controls.

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Category Accounts   Report



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