As accounting teams rush to implement policies and processes for the new ASC 842 standard, most companies aren’t looking past basic lease accounting compliance requirements. But they should.
There are important considerations for lease accounting beyond the basics of compliance including re-measurements, accounting workflows, lease terminations, audit trails and more.
Compliance with ASC 842 is complex, and the initial project will require significant resources. However, it is also important to remember after transition to the new accounting standards, companies will need to continue accounting for leases under those standards for years to come. Given the long-term ramifications, the value associated with go-forward efficiency and compliance will quickly outweigh the one-time compliance event. Leading companies are setting accounting policies and investing in solutions that will empower their teams for success well into the future.
Opening Balance Adjustments
A common question is, “Does the opening right of use (ROU) asset always equal the opening lease liability?”
The answer: Not always.
In fact, on many occasions the opening asset balance needs to be adjusted by items such as deferred rent (in transition), tenant improvement allowances and direct costs. It’s important that companies prepare for this likely scenario with a software that supports opening balance adjustments to the ROU asset.
Lease Modifications and Retrospective Re-measurements
FASB provided the following examples in ASC 842 regarding Lessee related lease modifications:
- Example 15—Modification Accounted for As a Separate Contract
- Example 16—Modification That Increases the Lease Term
- Case A—No Change in Lease Classification
- Case B—Change in Lease Classification
- Example 17—Modification That Grants an Additional Right of Use
- Example 18—Modification That Decreases the Scope of a Lease
- Case A—Remeasuring the Right-of-Use Asset Based on Change in Lease Liability
- Case B—Remeasuring the Right-of-Use Asset Based on the Remaining Right of Use
- Example 19—Modification That Changes the Lease Payments Only
In practice, there are many more variations. Companies must make sure the lease accounting policies and the software solution are set up to handle partial terminations, impairments, changing assessments of what is reasonably certain, data corrections, lease renegotiation events, and other company and industry specific scenarios.
All of these re-measurement events should be accounted for in the period in which they occur. However, some companies have been surprised at the number of retrospective re-measurement events. This common scenario happens when the accounting team receives information about lease events late, or after the impacted accounting period has closed. Accountants are familiar with booking true-up entries, which basically compare what should have been booked in prior period to what was actually booked and subsequent true-up which account for the difference in the current open period.
A quality lease accounting system will provide comprehensive tracking of all lease accounting related activity. This is essential for control over financial data, and can prevent costly issues when auditors come to visit. The audit trail should be available for lease level transactions and re-measurements. It should also be available for system generated reports. Lease Approval Workflow is also an important aspect included with quality software solutions. This feature facilitates separation of duties, approvals, reporting and email alerts when something changes, ultimately safeguarding company assets and promoting an efficient flow of information.
Some lessees are structured to provide month-to-month flexibility. Some have clauses that automatically transition a long-term lease into month-to-month status at expiration. In this situation, important items to consider are:
- Should the month-to-month lease be excluded from balance sheet reporting under the short-term exemption?
- How does company application of the reasonably certain evaluation of lease term apply?
- Does the software solution allow re-measurement ‘into’ and ‘out of’ month-to-month status?
Many companies are discovering that, while real estate leases make up the bulk of the total financial impact, equipment leases are actually more difficult to work with in the data collection process. This is usually due to the fragmented nature of equipment leasing practices at many organizations. Some common go-forward concerns include:
- The portfolio approach – should equipment be amortized and journalized as individual assets or as a group under the portfolio approach allowed by FASB?
- A central lease administration function for equipment – should we establish a new shared services function or a leasing center of excellence?
- Ongoing data collection – the exercise to collect all equipment leasing data for day one compliance is tough, but how will the company ensure accuracy and completeness going forward?
There’s no doubt compliance is an arduous task, however thoughtful organization of lease data can add value to the company. Organizing lease data in one system can allow the business to see patterns, eliminate waste and make more informed decisions. For example, a vendor may be charging for 150 pieces of equipment when only 100 are in use. How would the company know without a centralized repository of leasing information? While much of this current lease accounting work is motivated by compliance, ultimately the effort can promote efficiency and control, which can save the company a significant amount of money.
Learn more about how CoStar’s lease accounting software can track accounting workflow and create an audit trail of all data changes and other features useful for lease accounting compliance and Day 2 functionality.