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ASC 842 Lease Accounting: 10 Best Practices For Day Two And Beyond

ASC 842 Lease Accounting: 10 Best Practices for Day Two and Beyond

Adoption of ASC 842 lease accounting guidance is challenging, and most companies that have worked on compliance just want to get to a finish line. But it’s not a race. It’s an ongoing process that needs refinement to develop the ideal processes, controls, and systems for each organization’s unique needs.

Many public companies that already adopted the new standard made policy decisions and lease accounting software choices without fully understanding the nuances of reporting requirements. Now as the compliance deadline for nonpublic companies looms at the end of 2021, every organization can benefit from the experiences of those that have gone before them to chart a course – or even course-correct – for the optimal way to navigate ASC 842.

Here are 10 best practices for “day two” and beyond of lease accounting under ASC 842.

  1. Integrate the lease accounting system with the ERP system

Almost every lease requires multiple journal entry lines every period to amortize the ROU asset and lease liability balances, and to record proper expenses. Some lease accounting solutions don’t provide general ledger (GL) integrations. Some solutions offer integrations, but the journal entry integration may lack the ability to include amounts in functional currency, account for allocations, or conform to a company’s prescribed GL string format. The lack of integrations with a company’s ERP system forces accountants to download data from their lease accounting software and spend hours in spreadsheets manipulating columns into the prescribed format, removing unnecessary data, adding the right cost centers, allocations, and GL strings, and then uploading the journal entries into the ERP.

Flexible software integrates with all major ERPs and financial systems, including accounts payable and accounts receivable, reconciliation, and fleet vendors. These integrations create automatic workflows, save countless hours of manual workarounds and reduce the risk of errors.

2. Implement one seamless solution for lease accounting and lease administration

Lease accounting and lease administration teams often do the exact same data-entry tasks, taking hours out of each department’s day. For companies that have dozens or hundreds of leases, both departments could spend hours each month entering the same data. When lease accounting and lease administration are part of the same system, shared data reaches both lease accountants and lease administrators.

That’s important because both departments share a lot of data. They both need rent amounts, payment timing, and lease term dates. The lease admin team needs this data to ensure lessors are paid according to the lease contract. The accounting team needs the same data to calculate each contract’s ROU asset and lease liability to create the amortization schedule and meet requirements for ASC 842. Any time the rent or lease term changes, accountants and lease administrators need to know.

A comprehensive lease administration and lease accounting software solution alleviates the need for both departments to input duplicate data. Once data that both teams need has been entered into the lease administration module, the data appears in both modules. 

3. Automate lease remeasurements

Without automatic remeasurement, users must create manual calculations for renewals, terminations, partial terminations, and impairments.

Remeasurements occur often, yet many lease accounting software solutions have no ability to remeasure the amortization schedules. When performed within a spreadsheet, each type of remeasurement requires its own calculations, takes at least 30 minutes, and must be saved for auditors.

High-functioning lease accounting software automates remeasurements. Accountants can simply click on the type of remeasurement that is needed, and with just a few more clicks, the software automatically remeasures the ROU asset and lease liability, which is audit tracked as well.

4. Automate retrospective true-ups

If a remeasurement is missed and discovered after period-end close, when software does not automatically fix these issues, manual corrections must be made in spreadsheets. Accountants must show the amount that should have originally been booked, the amount that was booked, and the difference between the two. This tedious process takes even more time than the original remeasurement and creates another accounting record that is outside the software.

Mature lease accounting software automatically calculates the true-up based on the dates of an adjustment, posts the impact to the general ledger in the current period with no impact to a closed accounting period, and maintains an audit trail of the transaction.

5. Systematically control policy compliance and data quality

Companies must capture and maintain a high volume of lease data and associated amortization schedules and ensure the data is accurate for payment processing and lease accounting. Systems that can’t test lease data entries and bulk uploads for errors can cause big reporting problems down the road.

There are two main ways users enter incorrect data that software systems should test.

The first way is by manually entering data into a lease record. For example, ASC 842 says leases with a transfer of ownership clause should be classified as a finance lease. But accountants sometimes inadvertently tag them as operating leases. Other errors are made by incorrectly typing in data, such as numbers or text details.

Ideal software recognizes errors based on ASC 842 rules and provides instant error messages to users entering data. It also enables managers to run periodic “calculation exceptions” reports, which can identify issues across a portfolio of leases resulting from system problems, incorrect initial data entry, or problematic lease modifications.

The second way incorrect data is input into the system is via bulk uploads, which allows the addition of numerous data points in seconds. Software that can’t identify missing or incorrect data creates extra work downstream.

During bulk uploads, powerful software blocks those records whose fields contain incorrect or missing data. Users are immediately notified which records were blocked and which fields must be corrected before attempting to upload them again.

6. Automate reports needed for disclosures and auditors

Disclosure and roll-forward reports are required on a regular basis and should be automated to save time on repetitive tasks and ensure accurate details can be provided to auditors quickly.  

Disclosure reports

Most lease accounting solutions have a standard one-page disclosure report containing numbers required by ASC 842, but they lack lease-level supporting details that auditors need to ensure the total amounts listed are accurate.

Missing details require accountants to pull amortization schedules from each lease record so auditors can tally the numbers to ensure they equal the total amounts on the disclosure report. If the reported amounts differ from the auditor’s totals, accountants must then spend additional time discovering where the errors lie. When these discrepancies can’t be resolved, issues will be documented as errors in the audit.

In mature lease accounting software, all amortization schedules lie within the application, and supporting details for every lease is included with the disclosure reports.

Roll forward reports

Auditors commonly request lease accounting roll forward reports, which present three main things:

  • The company’s total balance of the ROU asset account and the total balance of the lease liability account at the beginning and end of a period
  • Numerical details that correspond with the following categories showing why the balances changed during that time: amortization, depreciation, additions, terminations, renewals and impairments
  • The balances and categories in total for the company and for each individual lease

Absent supporting details require accountants to pull separate reports from the ERP and their lease accounting software, perform VLOOKUPS in spreadsheets, and tie the reports together. Accountants must search through hundreds of lease records to identify balance changes associated with additions, terminations, renewals, and impairments. They then must assume that balance changes not identified in their search were due to amortization and depreciation. This entire process can take days to complete and is fraught with risk because auditors will test the assumptions.

Well-developed lease accounting software automatically runs a roll-forward report containing all supporting auditable details.

7. Customize reporting with company-specific fields

Companies frequently need reports based on specified lease data fields. Many companies have found that they can’t get reports formatted to their specifications out of their lease administration and accounting software. To get the data set that’s needed, accountants must run a standard report, export it to a spreadsheet, and then manually remove all other irrelevant records and fields.

Sophisticated software allows accountants to report solely on chosen fields and to filter by the company’s hierarchy. Users can drag and drop any lease data field into a report. Once an ad hoc report has been created, it can be saved as a template and shared with others.  

Individual data fields should be configurable as well. Most companies need to track information unique to either the business or industry, but many lease accounting systems don’t accommodate information outside their standard lease agreement fields.

An ideal system provides the ability for users to create customized data fields alongside standard lease data for ease of access and a single source of reliable information.

8. Maintain separate schedules for book/tax differences and other areas of accounting

Accountants frequently must break out lease details, such as TIA amortization for tax, purchase accounting adjustments and cease use adjustments from the ROU assets that were calculated based on the original lease liability.

The best practice is to split these items out into a parallel amortization schedule. Without the ability to split amortization schedules, accountants are forced to create supplemental schedules in spreadsheets outside the lease accounting system. Each instance may take an hour of additional work. 

Mature lease accounting solutions provide the flexibility to run parallel amortization schedules for book/tax differences and other areas of accounting while maintaining the correct combined balance for ASC 842 compliance.

9. Match the incremental borrowing rate to leases automatically

A critical input into lease accounting calculations is the discount rate for net present value calculations. Most companies use an incremental borrowing rate (IBR), but the challenge is finding the correct IBR for each lease.  Large companies have hundreds of rates to choose from as they’re based on geography, currency, lease term, and type of lease — either real estate or equipment.

Without the ability to automatically match discount rates to company rate tables, accountants must research rates and insert them manually. The fully developed software allows organizations to upload their discount rate tables to automatically assign the correct rate to each lease based on its terms.

10. Use market data to easily estimate the fair market value of real estate

The fair market value (FMV) of real estate is often needed for lease accounting calculations. FMV comes into play for finance vs. operating classification testing and impairment testing and is used to determine purchase accounting adjustments in business combinations. To obtain the support for FMV of their properties, companies typically go through a time-consuming process like this: The accounting department requests the FMV from the real estate department, which requests it from a real estate broker, who then uses researched data to derive the FMV and sends it to the real estate department, which forwards the information to the accounting department.

That process can take days. The best practice is to implement a lease accounting solution that readily provides researched real estate information such as market sales price per square foot, market rent per square foot, and market cap rates.  This information can be used to quickly estimate FMV, and since it is available within the lease accounting application, what used to take days can now be done in minutes.

Lease Accounting with CoStar

If your existing lease accounting software is missing these essential, time-saving functions – or if you’re looking to implement the company’s first solution – get the system that can do all this and more. CoStar.

CoStar is trusted and recommended by more leading accounting firms and service providers to manage and report on real estate and equipment for compliance with ASC 842 and IFRS 16 guidance. If your lease data is already in a database, upgrading is easier than you’d expect. Search “CoStar Lease Accounting” to learn more.

Matt Waters, CPA

Lease Accounting Subject Matter Expert with over 15 years of Management Experience in Accounting and Finance