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Lease accounting | Frequently asked questions

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Why did the FASB and the IASB change accounting for leases? people looking at graph A 2005 SEC survey estimated the off-balance sheet obligation associated with operating leases for public companies at $1.25 trillion. In 2016, the FASB and IASB issued new standards to bring these obligations on the balance sheet.

While the FASB and IASB standards are similar, there are differences between them. Both will mostly affect lessee accounting. The principal difference between the two standards is that the FASB standard retains a dual lease classification model that preserves the current lessee expense recognition pattern for operating (straight-line) and capital (accelerated) leases, whereas the IASB standard moves to a single model with one expense recognition pattern for lessees. (For more information on the differences, please see the “Summary” section, pages 7–9 from Accounting Standards Update (ASU) 2016-02, Section A – Lease Amendments to the FASB Accounting Standards Codification.)

When do I need to be compliant with ASC 842? The guidance in ASU 2016-02 will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2018. For all other organizations, it will take effect for fiscal years beginning after Dec. 15, 2019, and for interim periods within fiscal years beginning after Dec. 15, 2020. Early application is permitted for all organizations.

What periods are affected by the standard upon its adoption? Initially the new lease standard calls for a modified retrospective transition. So, 2017 and 2018 data generally is needed for adoption in 2019, for calendar-year-end public companies. However, based on an update made in 2018, the FASB has provided an optional transition method whereby companies can elect to reflect their adoption of ASC 842 at the effective date, as opposed to the earliest comparative period presented. The result is that companies can continue to follow ASC 840 for those comparative periods.

What happens to the straight-line provision in the income statement? The straight-line provision relates to the current pattern of expense recognition for operating leases. This pattern will not change for operating leases under ASC 842.

Do I really have to gather all lease information, or can I estimate? Is there a materiality threshold? Under International Financial Reporting Standard 16, low-value assets do not need to be recognized on the balance sheet. The IASB has indicated that low-value assets are those valued under $5,000 when new (as indicated by IASB). The guidance in ASU 2016-02, however, does not provide such an exemption although, as with implementation of any accounting standard, materiality should be considered. Many companies are considering whether a capitalization threshold, similar to what is used for property, plant, and equipment, can be applied for leasing.

Will I need software to track and account for leases under the new standard? Software selection often is an important part of implementing the leasing standard, and should be front of mind for any company undergoing this transformation. However, companies do have a lot of flexibility in terms of timing software purchase, and there is no need to select a software solution upfront. Rather, there are definite advantages (such as pricing or better alignment with your company’s needs) to waiting to select software until your company has identified and collected all its lease data. Your company can first prioritize the collection of data into a central repository, and then define the best-in-class processes and governance of updating and managing your data. Once you have this central repository, you can select the best software solution for your needs, since a central data repository should be able to interact with any software.

Going forward, will we need to change our approval process for new leases to ensure that we account for them at the appropriate time? It is important that you catch your leases upstream by thinking proactively of any new leases you are entering into from now on. Going forward, account for leases and put them on the balance sheet as soon as you contract them. This is important because it will not only ensure your future compliance, but also speed up your company’s transition process to the new standards. The first step toward implementing these proactive measures is to educate the people at your company’s various locations by establishing a process they can use to identify new leases. The second step is to assess the level of centralization of your operations. To acquire the best efficiency and to capture your data adequately, centralization may make sense. So, if not already there, your company might need to identify the necessary future steps it needs to take in this direction.

We have lots of groups negotiating leases; how do we find them all? Ensuring a complete population tends to be a heavy lift for companies. There are many steps that companies are taking to help ensure that the population is complete at the effective date, but also remains complete from a process and control standpoint.

The natural starting point is to utilize the data used to prepare the five-year footnote table under ASC 840. Once you have compiled the known population, it is important to look for the unknown, or embedded, leases that often were missed under ASC 840. Generally, we take a two-step approach to identifying embedded leases:

  1. Identify lease owners within the company, which allows you to have catalogued all groups negotiating leases. Then inform and train all these groups on the lease standard, and request that they verify and confirm that they forwarded all leases within their control.
  2. Perform a completeness check by searching accounts payable for recurring payment streams.

These two steps will ensure that your company can make a positive, confident statement regarding the completeness of your identified leases.

Finally, your company needs to plan for centralizing the review process once these groups are located. The key to this part of the process is finding the proper time to centralize contract reviews - such as legal review or procurement signoff - and ensure that all contracts go through that checkpoint going forward.

What departments in my company will be affected? Can finance manage this transition alone? Who should be part of the team for this initiative? Several departments in your company will be affected by the changes in lease accounting, including the finance department, but not exclusively. For example, with the addition of leases to the balance sheet, organizations should review existing contractual agreements, such as lending covenants, to seamlessly adjust to the new standard. Accordingly, it may be wise to include treasury, legal departments and others as part of a transition team.

For example, your company will have to take into account the impact on the following:

  • Treasury. The new standards will trigger the loss of the off-balance sheet benefit for financing operating leases, so your company might need to reconsider debt covenant compliance.
  • IT/Operations. Your company will probably needs new processes, systems and controls to gather lease data and account for current leases, as well as for future ones.
  • Tax. Your review of leases may uncover the need to book tax differences and taxes that have no basis in either the right of use asset or in the lease obligation, resulting in deferred assets/liabilities associated with every lease. In addition, there will be significant uncertainty regarding the way states will treat new assets for income, sales and property tax issues.
  • Regulatory compliance. Since leases will be recorded as new assets and liabilities on the balance sheet, this will have an impact on regulated companies, such as banks and others. To ensure compliance, these companies can anticipate additional scrutiny from regulators and should start preparing for the standard now, as well as start planning for more regulatory capital.

How do I know if I have an embedded lease? Your company will have to identify and record all leases on the balance sheet, so this means that you may need to reconsider your contracts not labeled as lease agreements (e.g., service agreements) to identify any embedded leases you might not previously have accounted for separately. For example, if you have agreements with third-party contractors, do these include the exclusive use of an identified asset? If the answer is yes, then the contract might contain an embedded lease.

Contact: Daryl Buck
National Managing Partner, Advisory Services
T +1 918 877 0824

Joseph Brown
National Managing Partner, Strategic Federal Tax Services
T +1 954 224 4171

Chris Stephenson
Principal, Financial Management
T +1 425 214 9821