Have You Started Implementing the New Lease Standard?
Large public companies that have already implemented the new lease standard are reporting that it takes much more legwork than they’d anticipated. The Financial Accounting Standards Board (FASB) recently approved amendments to the standard that were designed to aid implementation. However, many companies that lease assets are still running behind in terms of implementing the changes.
The updated lease standard is effective in 2019 for public companies and 2020 for private ones. Here’s why many companies that rent real estate, equipment and other types of fixed assets have delayed the implementation process.
Collecting lease data
The FASB published Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), in an attempt to end the much-criticized practice by which the assets and liabilities associated with leased equipment and property were kept off of company balance sheets. Businesses that don’t record their leases as liabilities look like they have higher earnings and more available funds than companies that finance new pieces of equipment or take out mortgages to build offices and stores.
The new standard is expected to usher in a major change to company balance sheets. Leasing is a pervasive practice across industries, with companies renting goods ranging from photocopiers to fleets of trucks to real estate. Many companies have for years disclosed in the footnotes to their financial statements details about the rent payments they make for these items.
The premise of the new accounting sounds simple enough: Report on the balance sheet the assets and liabilities associated with renting office space, vehicles, and most other rented property or equipment. But then the details kick in. In some cases, a contract that qualifies as a lease won’t have the word “lease” written across the top of it. Instead, a lease may be embedded in the fine print of a service contract.
A multinational company will have to dig through records overseas, in multiple languages and currency denominations, to tally up lease obligations. If a lease contract allows for modifications, such as rent price changes, this also must be taken into account. Those elements create a lot of unforeseen complexity that bogs down the implementation process.
Tracking and recording leases
To complicate matters further, many commercial accounting software systems can’t capture all of the nuances of lease contracts, from lease modifications to foreign currency adjustments. As a result, some companies are so worried about their accounting systems working properly that they’re abandoning automated solutions.
Instead, they’re adopting the updated lease standard manually and then worrying about updating their accounting systems at a later date. In turn, manual processes will be harder for auditors to test next audit season, which could lead to delayed financial statements and possibly restatements.
Hitting a moving target
The implementation process is even more challenging as the FASB makes last-minute changes to its guidance. Although many of the changes are designed to aid implementation, companies would have preferred for the FASB to have worked through the details long before the standard was set to go live.
For example, on July 30 — just five months before the standard goes into effect for calendar-year public entities — the FASB published ASU No. 2018-11, Leases (Topic 842): Targeted Improvements. This update relieves businesses and organizations from having to present prior comparative years’ results when they adopt the new standard. It also lets landlords and other lessors avoid breaking out the parts of a rental contract that aren’t specifically being leased, such as the cost of snow removal services, and account for them separately from the base rent.
In August, the FASB proposed additional changes for lessors. (See below for “FASB proposes 3 fixes for lessors.”) So, staying atop the guidance is an ongoing challenge.
For companies that lease assets, this standard will bring sweeping changes to the financial statements and footnotes. But the implementation process is time consuming. So, it’s important to work with an experienced CPA who is atop the latest developments and can help you implement the changes in a timely, cost-effective manner.
Sidebar: FASB proposes 3 fixes for lessors
A proposal from the Financial Accounting Standards Board (FASB) would provide some relief to real estate and equipment lessors as they try to implement the updated lease standard. Many lessors welcome the reprieve from an otherwise arduous implementation process.
Proposed Accounting Standards Update (ASU) No. 2018-260, Leases (Topic 842): Narrow-Scope Improvements for Lessors, simplifies three areas of lessor accounting:
- The breakout of sales and other types of taxes from lessor costs. This aspect raised concerns because it requires lessors to analyze sales taxes and other similar taxes on a jurisdiction-by-jurisdiction basis to determine whether the taxes are the primary obligation of the lessor, as owner of the underlying asset being leased, or whether the taxes are collected by the lessor on behalf of third parties. When a sales tax is collected from a lessee on behalf of a third party, the lessor is supposed to exclude the tax from the total amount of lease revenue. In contrast, when the lessor is primarily obligated for payment of the tax, the amount must be included in lease revenue and costs. For businesses operating across multiple jurisdictions, this exercise could be costly and complex. The proposal permits lessors to take an accounting policy election for sales and other similar taxes that would allow them to exclude taxes from the measurement of lease revenue and the associated expense. The lessor would, however, have to use the same accounting policy for all sales and other taxes covered by the policy election.
- The recognition of certain costs, such as insurance, paid directly by lessees. The proposal would allow lessors to disregard costs that lessees pay to cover rented equipment when accounting for their leases.
- The recognition of variable payments for lease and nonlease components of a contract. The proposal would permit lessors to not recognize variable lease revenue and the corresponding cost as an expense for certain lessor costs paid directly by the customer to third parties.
The FASB is planning to publish a final standard before the updated lease standard goes live for public companies in 2019.