Sustaining compliance after day two requires a rigorous focus on optimizing processes for ongoing management of lease accounting data and entries. As leases evolve over their lifetimes, organizations must maintain accurate tracking and financial reporting. A proactive approach to enhancing record-keeping, reconciliation and analytics will enable organizations to make more strategic business decisions after analyzing lease accounting data.
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Refining remeasurement and reassessment procedures
Under the new standards, subsequent remeasurements and reassessments of leases may be required in certain situations. In the day two phase, it's essential to refine the protocols around identifying events that warrant remeasurement or reassessment.
Let's look first at lease modifications. Lease modifications are any changes to the terms and conditions of a lease. Common examples include extending or shortening the lease term, adding or removing assets/spaces and changing lease payments.
When a lease modification occurs, remeasurement of the lease liability is required as of the effective date of the modification. The lease classification should also be reassessed at modification. You will need to calculate the modified lease liability using the revised lease payments, discounted at an updated discount rate as of the modification date. The right-of-use (ROU) asset will generally be adjusted by the change in the liability.
Notably, not all changes to a lease require modification accounting. An example of a change that would not call for modification would be one solely related to variable lease payments tied to an index or rate, which would be treated as a variable lease cost adjustment, not a modification.
Leases often contain options to extend or terminate the lease, requiring a reassessment of options. If the assumptions surrounding whether these options are reasonably certain to be exercised change, remeasurement is typically required.
For example, if initially an option to extend was deemed unlikely to be exercised, but during the lease term the lessee determines it is now likely to extend, remeasurement should occur on the reassessment date. The lease term would be updated based on the revised assumption, impacting the calculation of lease assets and liabilities.
A resolution of uncertainties can also warrant a remeasurement. This would be true for leases containing variable payments tied to usage or performance that are resolved once the uncertainty is eliminated.
If previously uncertain lease payments become fixed due to the resolution of any variables, remeasurement of the lease may be required on the date of that resolution. A good rule of thumb is that if the newly fixed payments were included in the original lease liability, a remeasurement is likely warranted.
When remeasuring a lease, it is critical to review the discount rate and lease classification in addition to payments. Often, freezing the original calculations and starting fresh are the best approach upon remeasurement. Proper change management and prompt communication across the organization when lease terms change are also key. Accounting teams need to be informed immediately when remeasurement events occur.
Reconciliations
Performing regular and rigorous reconciliations is critical for ongoing lease accounting compliance. Organizations should be reconciling their lease-related balance sheet accounts and expenses each period.
The key accounts to tie out include:
- ROU assets;
- Lease liabilities;
- Lease expenses (amortization and interest);
- Deferred rent balances; and
- Lease incentive balances.
Any reconciling items should be earmarked for resolution based on your research about the terms. Start by tracing back to the last period that was in balance to help identify when the imbalance originated. Once you've accomplished this, you'll be ready to review all lease accounting entries during that time frame for errors or improper postings.
Many organizations find it helpful to use a lease payment clearing account in their reconciliation process. Rather than booking cash lease payments directly to expenses, post them to a clearing account instead. Then, when the monthly lease accounting entries are recorded, offset the clearing account.
The payments hitting the clearing account should tie to the related cash outflows. Review entries thoroughly to ensure only appropriate lease accounting offsets are posted. Any remaining balance likely indicates a timing difference or error needing resolution.
For prior period lease accounting adjustments, recording the correction retroactively back to lease commencement is the proper next step. You'll still want to post any necessary adjusting entries to get the accounting current as of today. For example, if you failed to record a lease that started six months ago, book the ROU asset and liability from commencement, but also catch-up amortization and interest to cover your bases for moving forward. For organizations that do not open prior periods, it may be necessary to post all entries to the current period.
By performing rigorous account reconciliations, you'll position yourself to maintain compliant lease accounting and find issues quickly.
Assessing your lease portfolio
One of the major benefits of the new lease accounting standard is that it requires all leases to be recorded and tracked in a centralized, standardized way. This enhanced consistency and transparency enables new opportunities to optimize your lease portfolio.
With all leases visible in one place, organizations can now perform more robust analytics to reveal trends, inconsistencies and areas for improvement. Key areas to analyze across your portfolio include:
- Costs: Identify high-cost leases and determine if renegotiation opportunities exist. Benchmark costs for similar assets and analyze any outliers.
- Terms: Evaluate normalization opportunities for lease terms. Look for options to align renewal and termination options across similar assets.
- Options: Assess whether assumptions made about options remain appropriate. Consider market conditions and business needs when evaluating extensions or terminations.
- Other attributes: Review other lease details like payment frequency, security deposits and maintenance requirements for standardization opportunities.
These insights enable more strategic decision-making around lease versus buy analysis, as well as optimal timing for lease renewals, terminations and option exercises. Having all leases recorded centrally provides total visibility into the true costs and terms of leasing versus owning assets. Organizations can come to data-driven decisions about acquiring assets based on what makes the most financial sense.
In terms of timing, portfolio analytics may reveal that certain leases are significantly below or above market rates. For below-market leases nearing expiration, you can start to determine optimal timing to renew or allow termination. For above-market leases, you have the opportunity to consider renegotiation at optimal times.
Lease portfolio analytics may also reveal process and policy gaps that create additional risks and inefficiencies. For example, evaluating renewal notice requirements across leases can highlight gaps in internal controls and approval policies. Many companies discover leases renewed automatically without taking advantage of market conditions.
Evaluating trends can highlight opportunities to implement technology for automating manual processes like reconciliations or lease tracking. Moving from spreadsheets to dedicated software reduces the risk of errors and provides audit trails. Standardizing and centralizing compliance activities are also enabled by technology.
Ongoing lease portfolio analytics and assessments should become a regular discipline under the new standard. Resources dedicated to continuous monitoring of lease data will allow you to course-correct in real time instead of waiting until issues compound. Organizations that devote resources to continuous improvement will realize the greatest long-term benefits from their lease accounting compliance programs.
