If you're on a lease management team, you’re responsible for an expansive portfolio of land, office and equipment leases. 

Now, imagine that your portfolio increased more than 350%. 

That’s what happened to Richard Miller in his time at Rentokil Terminix. And it completely changed the way he operated his portfolio. 

Read Richard's story here

How Rentokil Terminix Chose Their Lease Management Software

Read Richard's story here

Mergers and acquisitions (M&A) are an almost inevitable part of doing business for enterprise organizations. 

“The nature of business is to acquire," said Tim Kolber, Managing Director of Accounting and Reporting Advisory Services at Deloitte. "And that has consequences from a lease accounting perspective."

“The nature of business is to acquire and that has consequences from a lease accounting perspective."

Tim Kolber

Managing Director, Deloitte

Tim Kolber

Strategic alignment, financial modeling and culture fit between merging companies are usually at the top of the priority list. But an area that can significantly influence the success of an M&A transaction is lease accounting. Lease accountants play a pivotal role in ensuring a smooth transition and financial integrity when two entities come together. 

How can lease accounting teams not only do their job but also do it well during a merger or acquisition? The same way they do everything else, by understanding the risks with lease accounting software. 

Understanding the portfolio & lease accounting compliance

A lease accountant's role is to analyze the lease portfolio, identifying:

• Key lease terms such as rent amounts, expiration dates, renewal options and escalation clauses. 
• Existing lease obligations and future financial commitments. 
• Any lease liabilities that may need to be recognized under ASC 842, ASC 805 or IFRS 16. 

Understanding ASC 805 compliance 

How do you know whether the transaction your company is doing even qualifies for business combination guidance (ASC 805) or not? 

“A business combination is defined as a transaction or other event which an acquirer obtains control of one or more business,” says Kolber. 

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The ASC master glossary adds a few more words. “A transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as true mergers or mergers of equals also are business combinations.”  

Here are some common ways of obtaining control of a business that fit the definition of ASC 805. 

• By transferring cash, cash equivalents, or other assets (including net assets that constitute a business)   
• By incurring liabilities   
• By issuing equity interests   
• By providing more than one type of consideration   

A business combination as defined by ASC 805 also needs to be within a certain structure. Some examples of structures are: 

• One or more businesses become subsidiaries of an acquirer. Or the net assets of one or more businesses are legally merged into the acquirer.  
• All of the combining entities transfer their net assets, or the owners of those entities transfer their equity interests to a newly formed entity.  
• One combining entity transfers its net assets, or its owners transfer their equity interests to another combining entity or its owners.   
• A group of former owners of one of the combining entities obtains control of the combined entity.   

Due diligence

One of the most important tasks in any M&A is due diligence. Lease accountants play a key role in finding lease-related assets and liabilities. They ensure that these transactions are accurate. This process involves: 

• Verifying that leases are properly classified as either operating or finance leases under current accounting standards. 
• Assessing potential hidden risks, such as early termination penalties, contingent rents or restoration obligations. 
• Ensuring that the target company's lease accounting practices comply with regulatory standards and that any deviations are flagged for resolution before finalizing the acquisition.  

Principles for reassessing lease classification during M&A 

As part of a business combination, a lease might be changed in ways that do not qualify as a lease modification. For example, a lease may be changed to reflect the new owner of the acquiree. Such a change in the name of one of the parties identified in the contract would not qualify as a lease modification.

Lease negotiations and renegotiations 

During the M&A process, lease accountants help renegotiate leases. This ensures the leases match the financial and operational goals of the new company. They provide critical financial insight on how lease modifications such as changes in rent or term extensions. These things can and will impact financial statements and overall business performance. 

For example, a merger might present an opportunity to consolidate real estate or equipment leases, renegotiating more favorable terms. This can lead to significant cost savings. However, you must conduct a thorough analysis from a lease accounting perspective to ensure that you properly account for any lease modifications. 

Potential assets or liabilities arising from an acquiree’s lease  

ASC 805 guidance tells us, “Regardless of whether the acquiree is the lessee or the lessor, the acquirer shall determine whether the terms of each of an acquiree’s operating leases are favorable or unfavorable compared with the market terms of leases of the same or similar items at the acquisition date.” 

To simplify, the acquirer needs to assess all leases to classify them. This ensures that current standards meet requirements and that you discover potential liabilities. This is a huge responsibility for the lease accounting team on the project but is a must-do step in the process. 

Purchase Price Allocation 

When one company acquires another, lease accountants play an integral role in the purchase price allocation (PPA) process. Under IFRS, companies are required to allocate the purchase price among the acquired company’s assets and liabilities, including leases. Lease accountants must: 

• Identify whether the lease is favorable or unfavorable compared to market rates. 
• Adjust the fair value of the lease liability and any right-of-use assets in the financial statements. 
• Ensure that any lease incentives or deferred rent balances are carried over correctly in the post-acquisition financials. 

Post-merger integration 

After the deal is finalized, the work of a lease accountant is far from over. In the post-merger phase, they are responsible for integrating the lease accounting processes of both companies, which includes: 

• Consolidating lease information into a single lease management system. 
• Ensuring that all leases are properly recognized and measured under the applicable accounting standards. 
• Handling ongoing lease modifications, terminations, or renewals in a way that reflects the new corporate structure and financial strategies. 

Additionally, lease accountants may need to assist in streamlining or consolidating leases for efficiency, as some locations or assets may no longer be needed after the merger. 

Impact on Financial Reporting 

Leases, especially in real estate-heavy industries, can have a significant impact on financial reporting. The acquiring entity must carefully integrate the lease obligations of the acquired company into its financial reports. Lease accountants ensure that the combined company's financial statements accurately reflect: 

• Lease liabilities and right-of-use assets. 
• Any impairment of leases, particularly in cases where duplicative or non-essential leases, are exited. 
• Changes in lease accounting estimates, such as discount rates or expected lease term, can affect the overall balance sheet. 

Lease accounting solutions

Lease accountants often rely on advanced lease management software to manage the complex array of leases. Post-acquisition, companies typically consolidate their leases into a single platform, helping to automate compliance with lease accounting standards.

Solutions like CoStar Real Estate Manager play a crucial role in this transition. A smart ASC 842 lease accounting software will streamline the lease accounting process and reduce the risk of errors. 

Lease accountants are vital to the success of any merger or acquisition. Their expertise, along with reliable ASC 842 software, ensures success. Whether it's through due diligence, renegotiation of lease terms or post-merger lease accounting software integration, lease accountants help ensure the long-term financial health of the combined entity. 

By focusing on the lease portfolio and managing it well, lease accountants offer important financial clarity. This ensures that the M&A transaction is a strategic success instead of a financial burden.