Which approach is best for ASC 842 and IFRS 16 compliance?
The new lease accounting guidance from both the FASB and IASB focuses on asset-level lease accounting, where debits and credits for each asset on a lease contract are created for the financial statements. Many businesses use a variety of leased real estate and equipment, which creates the need to capture a host of data points on each asset for financial reporting. However as a practical expedient, companies may account for leases at a portfolio-level as long as the results do not materially differ from accounting for the leased assets separately.
So how should companies determine which approach is better? First, review the key difference in definitions:
What is portfolio-level lease accounting?
Portfolio-level lease accounting, which many times can be narrowed in scope to contract-level lease accounting, is the process of recording transactions by generating the debits and credits for each lease contract or group of lease contracts.
From an accounting compliance perspective, portfolio-level lease accounting is typically a good option when there are no asset-level variations. Examples include real estate leases that have one asset per lease contract – like a store or parcel of land – or equipment leases with no asset variations throughout the lease and the same start and end dates for all assets. The similar characteristics of the agreements to lease these assets permit the use of the portfolio approach because calculations can be made in aggregate that are not materially different from accounting for each asset separately.
What is asset-level lease accounting?
Asset-level lease accounting is the process of recording transactions by generating debits and credits for each individual asset on a lease contract. This approach is typically utilized when material asset-level variations exist.
Asset-level variations – such as different start and end dates or different assumptions regarding purchase or renewal options – make aggregate calculations very complex or impossible. Thus, asset-level lease accounting becomes useful for complex leases involving multiple equipment assets on a single contract or real estate leases containing multiple sites or segments of a building. Debits and credits for various items can still be aggregated for journal entries, but the underlying schedules need to be separate. Couple this with the need for many companies to separate lease and non-lease components, and it’s no wonder that most are turning to a robust lease accounting and management software solution to facilitate.
Choosing the best approach
Grouping leases together under the portfolio approach may offer some cost relief upfront due to the simplified administrative lift required. However, portfolio-level accounting may not always be feasible due to variation, and performing asset-level lease accounting can improve visibility into business operations and allow for specific cost-saving decisions to be made for individual leased assets.
Choosing a proven lease accounting and management software from CoStar allows you to manage leases in the manner that best suits company practices and process, no matter which approach is favored. And it’s worth noting that the FASB and IASB allow for companies to choose the preferred approach on a lease by lease basis, so no one approach is “locked in” as long as the tact selected accurately represents the underlying transactions.