When It Comes to Lease Accounting, Plan Ahead, Weigh Your Options, and Know Your Environment

Antonio G Ginting

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As we pass the midpoint of the fiscal year and financial leaders start thinking about year-end deadlines, the new lease accounting standards may not seem like a top priority. But preparing for implementation now can position you for success and eliminate any last-minute hurdles.

Financial Accounting Standards Board (FASB) ASC 842 and Governmental Accounting Standards Board (GASB) 87 both require entities to evaluate all contracts relating to right-of-use assets for recognition in financial statements. Previously, lease standards allowed operating leases to be reported in a way that did not clearly reflect commitments made by the lessee. Thus, only capital leases were recognized as an asset and liability in the financial statements, and liabilities associated with operating leases were only disclosed in the notes to the financial statements.

Moving forward, for contracts that qualify, entities are required to report a lease asset and liability. ASC 842 also requires that leases be classified as either operating or financing, which can impact their presentation on income and cash flow statements. Meanwhile, GASB 87 requires that all leases be reported as financing activities, which significantly changes how entities report expenditures in governmental funds.

The new lease standards will cause many companies to report a new asset and liability on their financial statements. It’s not only important for companies to understand how this will change internal reporting, but also how their financial statements will be viewed by third parties, especially when seeking future financing. With the year-end deadline quickly approaching, companies need to start designing and implementing accounting processes that meet the new requirements.

Stay ahead of the deadline with the right planning

As with any project, the more time spent on planning and preparation, the better chance of successful execution. Start by developing a high-level project plan and establishing a steering committee to provide project oversight, all within an achievable timeline.

These standards may require a bit more effort to implement than expected, but with the right preparation, professional guidance, and resources, companies can be in good shape by the end of the year. To stay ahead, companies should consider the following:

  1. Understand how many leases you have and gather all relevant information. Analyze existing leases, service arrangements, and other contracts to determine if they meet the definition of a lease under the new standards. To make this easier, establish an internal control that requires all contracts to be evaluated under the new lease standards.
  2. Find a software solution to account for leases moving forward. This will look different for each organization. The tool you use is completely different when accounting for one lease versus one hundred.
  3. Evaluate each contract, record journal entries and determine the impact on your financial statements. Learn how the new standards impact internal controls and each functional area of the entity and consider making changes. This is especially important for entities with loan covenants or for those who are seeking financing.

Be mindful of new terminology

One of the changes within the new standard is that assets that previously met the criteria of a capital lease are now referred to as a “finance lease.” One of the most common characteristics of a finance lease is the transfer of ownership to the lessee at the end of the lease. Large equipment such as forklifts, airplanes, and excavators often fall into this category. The most common example of operating leases relates to real estate. Evaluate each contract individually to determine the correct classification. Under the right circumstances, these lease arrangements could easily fall into either category.

Tools to get started

Accounting for leases will depend on how many you have and what type of information you need to manage your business. There are several simple tools and enterprise solutions available to help companies meet their financial reporting and management needs. Simple Excel-driven solutions can help crunch the numbers and provide the basis for journal entries — while enterprise solutions can automate journal entries and easily create draft financial note information. These enterprise solutions can also help companies manage and evaluate their leases.

When deciding on a solution, organizations should consider their unique needs and talk with multiple vendors. Software vendors can provide demos and an overview of how their product can help you manage your business. Don’t get distracted by features that look great but you will never use.

Understanding your lease environment and being proactive when entering into new leases is how organizations can ultimately prepare for the transition. Your knowledge and understanding of how each contract is structured directly impacts financial reporting. Consider modifying historical language when entering future contracts to make sure the accounting properly reflects the circumstance. Though the implementation process can be time consuming and expensive, being resourceful and seeking outside guidance can streamline the process and position you for successful year-end reporting.

Walker Wilkerson is Managing Principal of National Assurance at CLA. He is located in Lakeland, Florida.

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