The deadline for implementing the new accounting standards for IFRS 16 / ASC 842 leases is fast approaching. The new standards will require organizations to declare and disclose all rental obligations for buildings, offices, motor vehicles and other equipment, and reclassify them as assets and liabilities. Does your organization have an implementation plan and adequate system in place that will meet the new requirements?
The new IFRS and FASB guidelines for accounting for leases are described in IFRS 16 and US GAAP ASC 842. The big change is that all leases will now be recognized as assets and liabilities, unless the lease term is 12 months or less, or the underlying asset has low value. For more details on the differences between IFRS 16 and ASC 842, download this Guide to Accounting for PWC Leases.
The changes will force companies to:
• Track details of all rental contracts (buildings, cars, offices, equipment, etc.).
• Break down contracts into relevant elements that determine the classification of the assets and liabilities of the right of use.
• Make the appropriate calculations.
• Generate appropriate journal adjustments to accurately reflect leases on the balance sheet and income statement.
The new IFRS guidance applies to reporting periods beginning after January 1, 2019. For organizations reporting under US GAAP, ASC 842 applies to public companies for reporting periods after December 15, 2018 and to other companies a year later.
Business preparation is lagging behind
As has been the case with revenue recognition and other accounting changes, preparation for the new lease accounting guidance is lagging behind, and many organizations will strive to comply in the second half of 2018. According to a recent Robert Half / Protiviti survey, more than half of the companies surveyed (56%) have not started the transition to the new lease accounting standard. Sixty-nine percent of the largest companies have started the process, compared to 37 percent of the smallest organizations surveyed. The top four challenges businesses face in transitioning include training staff, diagnosing needed changes, finding professionals with the required expertise, and updating their technology.
Too complex and risky for spreadsheets
The usual response for organizations when faced with new accounting guidelines like this is to solve the problem using spreadsheets. But the new lease accounting guidelines are a bit too complex for spreadsheets.
There may be hundreds or even thousands of leases in the various operations of a large global corporation. These must all be captured and classified. Then the calculations must be performed. In addition, appropriate journal adjustments should be made to report the asset, liability, and periodic depreciation of the lease. The volume of data and calculations will be too much to handle in spreadsheets, and most general ledger systems aren’t designed to handle lease details – or the calculations for them.
Best practices in lease accounting
A better approach to managing the new lease accounting guidelines is to select an application specifically designed to capture all of the relevant lease details, and then manage the calculations, reports, forecasts, and accounting adjustments needed to reflect the impacts of the new directives. in the balance sheet and in the income statement.
When evaluating lease accounting software solutions, several approaches should be taken into account:
Custom applications: An organization can ask their IT department to create an in-house lease accounting solution. This could be cost effective, but would likely be time consuming due to competing projects and would require a thorough knowledge of lease accounting guidelines to be effective. This approach will also require the involvement of your auditors for the validation of the IT audit.
Stand-alone applications: There are several packaged applications available in the market that can immediately meet lease accounting requirements. These solutions are expected to deliver faster payback times than custom applications. However, there will be licensing, maintenance, or cloud subscription costs involved, as well as training and implementation costs. Many of these solutions are actually developed for specific lease types like real estate. For many businesses with complex leases, this may not be relevant. Tailoring these solutions to your needs can be very expensive or even impossible.
Integrated applications: Some existing software applications offer rental accounting solutions as an extension of their system. Examples would be enterprise resource planning or enterprise performance management software packages with built-in rental accounting modules. This approach provides a purpose-built solution, while maximizing your investment in the existing software platform. Another benefit is the ability to record journal adjustments related to lease accounting directly to the general ledger or corporate consolidation system.
The main requirements to look for in a rental accounting software solution include:
• Captures all applicable details for hundreds or thousands of leases;
• Handles all necessary calculations, i.e. allocation of principal and interest on lease payments, calculation of the present value of the lease, amortization of costs capitalized over the term of the lease, processing contract extensions, subleases and even complex contracts such as multi-currency contracts;
• Generates the applicable journal entries to record and depreciate the corresponding asset and liability;
• Provide full audit trails for all balance sheet and income statement adjustments; and
• Ease of administration and updates.
It’s time to move
Whichever approach your organization considers, it is clearly time to move on to the new lease accounting guidelines that will come into effect at the end of 2018. Much of the initial work required will focus solely on identification. and collecting leases from all of your business and putting the relevant details into a central database. Next, you need to implement and configure a software solution that can meet the new guidelines and any other changes that may arise in the future, in lease accounting and other compliance requirements.