Getting ready for the new lease accounting guidelines

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The implementation deadline for the new IFRS 16/ASC 842 lease accounting standards is rapidly approaching. The new standards will require organizations to report and disclose all lease obligations for buildings, office space, 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 lease accounting are described under IFRS 16 and U.S. 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 a low value. For the details on the differences between IFRS 16 and ASC 842, download this PWC Lease Accounting Guide.

The changes will require companies to do the following:

• Track the details on all lease contracts (buildings, cars, office space, equipment, etc.).

• Break down the contracts into the relevant components that determine the classification of the Right of Use Assets and Liabilities.

• Make the appropriate calculations.

• Generate the appropriate journal adjustments to accurately reflect leases on the balance sheet and income statement.

The new IFRS guidelines are effective for reporting periods beginning after Jan. 1, 2019. For organizations reporting under U.S. GAAP, ASC 842 is effective for public companies for reporting periods after Dec. 15, 2018, and for other companies a year later.

Corporate Readiness is Lagging

As was the case with revenue recognition and other accounting changes, readiness for the new lease accounting guidelines is lagging, and many organizations will be scrambling to comply in the second half of 2018. According to a recent Robert Half/Protiviti survey, more than half of companies surveyed (56 percent) have not begun transitioning to the new lease accounting standard. Sixty-nine percent of the largest firms have started the process, compared to 37 percent of the smallest organizations surveyed. The top four challenges firms face in the transition include training staff, diagnosing the needed changes, finding professionals with the requisite expertise and updating their technology.

Too Complex and Risky for Spreadsheets

The usual response for organizations when they’re faced with new accounting guidelines such as this is to address the problem using spreadsheets. But the new lease accounting guidelines are a bit too complex for spreadsheets.

There can be hundreds to thousands of lease contracts across the various operations of a large, global company. These must all be captured and categorized. Then calculations must be run. Plus, appropriate journal adjustments must be made to report the asset, liability and periodic amortization of the lease. The volume of data and calculations will be too much to manage in spreadsheets, and most general ledger systems aren’t designed to manage lease details — or the corresponding calculations.

Best Practices in Lease Accounting

A better approach to managing the new lease accounting guidelines is to select a purpose-built application that is designed to capture all the relevant lease contract details, then manage the calculations, reporting, forecasting and accounting adjustments required to reflect the impacts of the new guidelines on the balance sheet and income statement.

When evaluating lease accounting software solutions, there are several approaches to consider:

Custom applications: An organization can commission its IT department to build a home-grown lease accounting solution. This could be cost-effective but would likely take a long period of time due to competing projects and require in-depth knowledge of the lease accounting guidelines in order to be effective. This approach will also require the involvement of your auditors for IT audit sign off.

Standalone applications: There are several packaged applications available on the market that can address lease accounting requirements out of the box. These solutions should provide a faster time to benefit vs. 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 types of leases like real estate. For many companies with complex lease contracts, this might not be relevant. Adapting these solutions to meet your needs can turn out to be very costly or impossible.

Integrated applications: Some existing software applications offer lease accounting solutions as an extension of their system. Examples would be enterprise resource planning or corporate performance management software packages with integrated lease accounting modules. This approach provides a purpose-built solution, while leveraging your existing software platform investment. Another advantage is the ability to post lease accounting-related journal adjustments directly to the general ledger or corporate consolidation system.

Key requirements to look for in a lease accounting software solution include:

• Captures all the applicable details for hundreds or thousands of lease contracts;

• Handles all of the required calculations, i.e., breaking out principal and interest on lease payments, calculating the present value of the lease, amortizing the capitalized costs over the life of the lease, handling extensions of contracts, subleases and even complex contracts such as multiple currency contracts;

• Generates the applicable journal entries to record and amortize the asset and corresponding liability;

• Provides full audit trails for all balance sheet and income statement adjustments; and

• Ease of administration and updates.

Time to Get Moving

Whichever approach your organization is considering, it is clearly time to get moving with the new lease accounting guidelines coming into effect at the end of 2018. Much of the initial work required will focus on just identifying and gathering lease contracts from across your entire enterprise and putting the pertinent details into a central database. Then you need to implement and configure a software solution that can address the new guidelines and any other changes that may come in the future, in lease accounting and other compliance requirements.

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