Implementing the New Lease Standard

By: Rafael Vidal, CPA – President & Co-Founder
Ellen DeGregorio, CPA – Senior Manager, Finance & Accounting Services
 
balance-sheets-with-calculator-and-magnifying-glass
 
In early 2016, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2016-02, Leases and the International Accounting Standards Board (IASB) released IFRS 16, Leases.  The new lease accounting standards will fundamentally change the rules that govern accounting for a majority of all leases, including real estate and equipment leases.  We expect the standard will have widespread implications in a variety of areas including but not limited to accounting, finance, tax, reporting, real estate, information systems, and technology.
 

Why a New Lease Accounting Standard?

In 2006, the FASB and IASB began a joint effort for the purpose of revising lease accounting standards. The goal was to improve and converge Generally Accepted Accounting Principles (GAAP) & International Financial Reporting Standards (IFRS) to reflect leasing obligations on a company’s balance sheet.  This effort was consistent with identified problems in an SEC study in 2005 on off balance sheet financing.  In that study, the SEC identified leasing as the largest off balance sheet financing transaction with $1.25 trillion of liabilities in leasing off balance sheet.  
 
The new lease standard attempts to convey in a balanced way the true economic position that a company enters into when it obtains access to capital in a form of a lease.  In other words, representing on balance sheet liabilities that a company incurs.  The issue with current GAAP, in terms of lease accounting, is the unrepresented obligation on the balance sheet representing the company’s right to assets and the obligation to pay for those assets.  
 

Overview of Benefits and Costs

overview-of-benefits-and-costs-graph_0

What is the Effective Date?

effective-date-graph_0

Key Differentiators

Over the last ten years, we have a standard that has been subject to many comments including concerns around the costs and complexity of the proposed new standard.  One of the biggest concerns was how any new standard would affect the expense recognition related to leases?

The good news is the FASB in 2015 voted to keep the recognition, measurement, and presentation of expenses and cash flows relatively consistent with existing GAAP.  There continues to be a differentiation between operating leases and finance leases as illustrated below.  In the new ASU, the term “finance lease” is substantially the same as what is known as a “capital lease” under existing GAAP.
lease-classification-graph_0
short-term-lease-graph_0

How Prepared are you for the Transition?

Recognizing lease-related assets and liabilities could have significant financial reporting, operational, and business implications as follows:

  • Key balance sheet or profit & loss metrics could change
  • Debt covenants and borrowing capacity might be affected
  • Decisions about whether to lease or buy significant assets might change
  • Enhanced disclosure requirements
  • Review of lease tax classification – any changes in classification may require IRS consent
  • Data collection and aggregation across multiple locations and technology platforms
  • Technology capabilities to store lease data and perform calculations, including calculations during the lookback period (comparative prior periods)
  • Transforming from paper documents to sustainable technology solutions
  • Impact of limited resources and ongoing business needs on timeline for adoption

Early action is key to a successful transition and organizations should consider creating a transition timeline and action plan. As a part of transition planning, organizations may want to form a transition team that includes individuals from departments other than accounting and external reporting.

Finally, but perhaps most importantly, organizations will want to explain the effects of the changes in accounting for leases on the organization’s financial statements to boards of directors, investors, and other users of financial statements.

 

Initial Project Plan may include:

  • Understanding the accounting requirements
  • Understanding the lease population (e.g., by type, system, and location)
  • Assessing current state processes and controls for the lease population
  • Assessing capabilities of existing technology
  • Performing a lease data gap analysis
  • Developing an implementation roadmap that includes all impacted areas

Implementation of the new standard may be a good opportunity for organizations to challenge the efficiency and effectiveness of existing processes and controls, particularly those related to ensuring all material leasing activity is accounted for.

 

How ProNexus Can Help

With adoption for calendar year-end companies in 2019, there will be less than three years to think through the potential impact, particularly in light of the requirement to retroactively apply the standard to previously issued financial statements. ProNexus can assist clients in a variety of areas including but not limited to the following:

  • Developing and/or directing the Initial Project Plan and implementation thereof
  • Understanding the accounting requirements and lease population
  • Assessing current state processes, information requirements, and capabilities of existing technology
  • Impact on financial statements and covenants
  • Lease data gap analysis
Post by Kaitlin Alfvin

Comments are closed.