Successfully Transitioning to the New Lease Accounting Standard

If your business deals with leases, your team needs a good grasp on the new lease accounting standard that’s relevant to you (ASC 842, IFRS 16 or GASB 87). As of January 2022, businesses must keep in-depth records for leases to stay compliant. We’re here to help you navigate these new standards. Read on to understand why lease auditing has changed or skip to the specifics of the ASC 842, IFRS 16 or GASB 87.

Back in 2006, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) agreed to prioritize the convergence of lease accounting. At that time, many prominent businesses leveraged loopholes in the old standard to structure lease agreements to keep them off the balance sheet and skew financial ratios in a more favorable direction. Because of this abuse, the SEC sent a letter to the FASB (US Financial Accounting Standards Board) and IASB (International Accounting Standards Board) asking them to take action and develop a standard that more accurately reflects a company’s true liabilities.

At this point, the SEC, the FASB and IASB initiated a joint project to develop a new lease standard but parted in 2016 due to differing opinions on whether or not to maintain lease classifications (operating versus financing) in the new standard.

Shortly after the issuance of new IASB and FASB guidance on lease accounting (IFRS 16 & ASC 842), the GASB followed suit and issued new guidance of their own in June 2017.

Here’s a timeline of the new standards:

The new standards now require virtually all leases to be reflected on the balance sheet. A “lease liability” is recorded at lease commencement, and a new “right of use” (ROU) asset account is introduced for all lease types. The resulting change has the biggest impact on what were previously operating leases, as shown in the diagram below.

The primary area where the IASB and FASB had their “great schism” on lease accounting is in determining whether there should be separate presentation for operating or financing leases on the income statement. The FASB elected to maintain a clear distinction between Operating Leases (with expenses recorded as operating costs and included in EBITDA) and Financing Leases (where amortization and interest expenses are below EBITDA). The IASB and GASB decided to reduce complexity, so they eliminated the separate operating classification. The net impact on the P&L for IFRS & GASB is a movement of lease expenses below EBITDA, as shown in the diagram below.

Previously, a fixed-payment operating lease was simple, and monthly entries were all the same, as shown below.

Now, it is much more complex.

• Initial Measurement: On the commencement date, a lease liability is recorded as the present value of all future lease payments. A right of use asset is recorded at the same amount, adjusted for initial direct costs, prepayments or incentives.
• Subsequent Measurement for Finance Leases: Accounting for finance leases under the new standard is similar to capital leases under the old standard. The lease liability is treated as debt and accounted for using the effective interest method, where interest expense is incurred monthly and the liability is reduced as payments are made against the liability. The capitalized right of use asset is treated like a fixed asset and amortized on a straight-line basis over the lease term. See initial and monthly entries below.

• Subsequent Measurement for Operating Leases (ASC 842 only): Accounting for operating leases is a new concept to get your arms around. Lease expenses are still required to be recorded on a straight-line basis, and the lease liability is required to be brought down using the effective interest method. This imbalance between decreasing interest accretion and a constant expense requires you to “plug” your monthly draw-down of your ROU asset (via accumulated amortization). The plug amount will typically increase over the lease term, as shown below.

The ASC 842 is intended to paint a clearer picture of a company’s true liabilities by placing (nearly) all leases on the balance sheet. Since many companies are still reeling from ASC 606 (the new revenue recognition standards) it may take some time to fully adopt the new ASC 842 standards. This quick guide can help you understand and plan for the change.

This new lease accounting standard has been in the works for almost 15 years. With a nudge from the SEC in 2006, the FASB and IASB initiated a joint project to develop a new lease standard. When the FASB first issued the new standard, ASC 842 was to be effective for public companies on January 1, 2019, and for private and not-for-profit organizations on January 1, 2020. However, after seeing the difficulties public companies faced in adopting the new standards, the FASB voted to give private & not-for-profit companies an additional year to comply.

For the presentation of operating and finance leases on the income statement, the FASB elected to maintain a distinction between operating and finance leases. In the case of operating leases, an operating cost expense is recorded and included in EBITDA. For financing leases, depreciation and interest expenses are recorded below EBITDA.

Under the old standard, a fixed-payment operating lease was simple, and monthly entries were all the same:

Under ASC 842, the same scenario is much more complex:

Under the new standard, there’s an initial journal entry and subsequent journal entries that change each month:

• Initial Journal Entry: When the lease is commenced, a lease liability is recorded, which is equal to the present value of all future lease payments. A right of use asset is recorded for the same amount and adjusted for initial direct costs, prepayments or incentives.
• Subsequent Journal Entries: Accounting for operating leases is a new concept to understand. Lease expenses must still be recorded on a straight-line basis, and the liability is brought down using the effective interest method. The imbalance between decreasing interest accretion and a constant expense requires companies to “plug” their monthly draw-down of their ROU asset via accumulated amortization. The plug amount will typically increase over the lease term, as shown in the example above.

The IFRS 16 became effective for annual reporting periods beginning on or after January 2019. This also applies to companies subject to AASB 16 (Australia), PFRS 16 (Philippines), JMIS (Japan), Hong Kong FRS or similar governing bodies. Despite the passing of the effective date, companies still have a lot of work ahead to comply with IFRS 16.

Here’s what you need to know for compliance with IFRS 16.

Starting in 2006, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) initiated a joint project on leases so balance sheets would more accurately reflect a company’s true long-term liabilities. Thirteen years later, these standards are finally beginning to take effect.

The IASB decided to reduce complexity and eliminate the separate operating classification of operating and finance leases. The net impact on the P&L is that expenses for leases previously classified as operating will now be recorded as amortization/depreciation and interest, as shown in the diagram below.

Prior to IFRS 16, a fixed-payment operating lease was simple, and monthly entries were all the same (see below).

Under IFRS 16, the same lease now requires an initial entry and subsequent entries that change each month:

• Initial Entry: On the date, a lease is commenced a lease liability is recorded at the present value of all future lease payments. A right of use asset is also recorded at the same amount, adjusted for initial direct costs, prepayments or incentives.
• Subsequent Entries: Accounting for finance leases under IFRS 16 is similar to capital leases under IAS 17. The lease liability is accounted for using the effective interest method, where interest expense is incurred monthly and the liability is reduced as payments are made against the liability. The capitalized right of use asset is treated like a fixed asset and amortized on a straight-line basis over the lease term.

Though the effective date of IFRS 16 has passed, many businesses are not yet properly complying with the new standards or leveraging a sustainable system to account for leases in the future. If you haven’t done so already, evaluate potential software solutions that can perform the proper calculations and reduce the risk of error associated with spreadsheets.

Most state and local government entities that deal with leases are required to comply with a new lease accounting standard, GASB 87 as of June 15, 2021. This new standard brings leases onto the Statement of Net Assets that previously were not. Although the effective date has passed, many agencies are still struggling to implement the new standard. They’re not alone, international and public companies are also transitioning to their own new lease accounting standards (IFRS 16 and ASC 842).

Here’s a quick summary of the key components of GASB 87 that all government agencies should know.

The GASB first issued a lease accounting standard (GASB 13) in 1990 that closely resembled the FASB’s guidance on lease accounting. Shortly after the issuance of new IASB and FASB guidance on lease accounting (IFRS 16 & ASC 842), the GASB followed suit and issued new guidance of their own in June 2017. Here’s a brief history of GASB 87, and when government agencies need to be compliant:

The GASB’s old lease accounting rule (GASB 13) was derived from the FASB’s statement No. 13 and therefore, GASB and FASB entities reported leases similarly. However, under the new standards, FASB and GASB entities will apply different accounting for operating type leases. Similar to IFRS 16, GASB 87 eliminates the classification of an operating lease (unless it’s short-term).

Previously, a fixed-payment operating lease was simple, and monthly entries were all the same:

Now the accounting is much more complex:

Here’s a breakdown of the accounting under the new standard:

• Initial Journal Entry: When the lease is commenced, a lease liability is recorded, which is equal to the present value of all future lease payments. A right of use asset is recorded for the same amount and adjusted for initial direct costs, prepayments, or incentives.
• Subsequent Journal Entries: Accounting for operating leases is a new concept to understand. Lease expenses must still be recorded on a straight-line basis, and the liability is brought down using the effective interest method. The imbalance between decreasing interest accretion and a constant expense requires companies to “plug” their monthly draw-down of their ROU asset via accumulated amortization. The plug amount will typically increase over the lease term, as shown in the example above.

Unlike the lease standards issued by the other accounting standards boards (IASB & FASB), the GASB has provided limited practical expedients and transition relief to GASB 87 entities. Therefore, it’s even more critical for government entities to respond early. Evaluate software solutions specifically developed for GASB 87 that can perform the proper calculations, without the need for manual calculations in Excel.

Under the new standards, more disclosures are required. Often when a new accounting standard is implemented, disclosures are an afterthought. The result can be a last-minute scramble to be in compliance fraught with error.

The smarter approach is to consider disclosures early in their adoption process. Disclosure compliance should be the main consideration when selecting a technology platform for accounting. It must collect the right information to support disclosures on the front end, so you are prepared for reporting on the back end.

Future minimum payments were always a required disclosure under the old lease accounting standards. But now, under ASC 842, IFRS 16, and GASB 87 disclosures have become more complicated. Here’s a list of some of the new disclosures required under the new standards for lessees:

Leases have a variety of options including renewal, expansion, termination and purchase. Any applicable options must be outlined along with details of those options, exercise dates and the likelihood of exercising the option. In the case of renewal, you must disclose any leases that auto-renew.

Many companies think that because a short-term lease is not reported on the balance sheet, no disclosure is required. However, if you exercise any short-term lease exemptions, you must disclose the amount of the lease expense associated with these short-term leases.

The purpose of the new lease accounting standards is to more accurately represent a company’s true liabilities and leasing activities. Therefore, there are several new values that must be reported on financial statements. There is, of course, the right of use asset and corresponding lease liability (broken out between current and long term). However, this also includes all costs associated with leases: operating lease costs, finance lease costs (ASC 842), short-term lease costs and variable lease costs. Additionally, income from subleases, net gains or losses from sale and leaseback transactions, cash paid for measurement of lease liabilities, supplemental non-cash information, weighted average remaining lease terms and weighted average discount rates must all be disclosed.

To ease the transition for companies, the FASB and IASB issued several practical expedients and transition relief. If companies elect any of these expedients they must also be disclosed. For example, short-term lease exemption, separating lease components, election not to restate comparative periods upon adoption and hindsight.

In addition to the disclosures above, additional detail is required, including maturity analysis of liabilities and lease transactions with related parties.

Read on to learn about lease-accounting software options that support disclosures.

The first step to becoming lease accounting compliant is to understand the lease accounting standards including ASC 840, ASC 842, IFRS 16. When you become acquainted with the new standard, you will be able to identify how the new standards apply to your company and leases. Understanding how the standard applies to your company will give you a better understanding on which route you want to take in becoming lease accounting compliant.

The different paths to becoming compliant range from performing all duties in house to completely outsourcing all processes. This article will present the different avenues available to companies and their pros and cons.

One way to save your team time and money is to use our free NetLease Template. You can cut the time used in DIY-ing your own spreadsheets to almost no time by just clicking and downloading. Reassure yourself of the accuracy and trustworthiness of your lease spreadsheets by using the NetLease Template.

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We have often heard that implementing the new lease accounting standard took far more time, resources and money than companies anticipated. In fact, many public companies with larger lease portfolios have spent millions of dollars implementing. For smaller companies that cost would be unthinkable.

So, what should you do? Will managing your leases in Excel be sufficient, or do you need software? How much will it cost? To help find the answers, ask these questions:

However, there is much more to consider before setting on Excel for more than a small handful of leases. Compliance is not simply developing a lease amortization schedule and booking journal entries against those period balances—this is just one step.

You will ultimately need to report lease amortization, modifications, terminations and aggregation. Relying on Excel will make it difficult to accurately aggregate information and report across a larger number of leases and schedules.

Furthermore, you will need to track additional lease disclosure information such as options (purchases, extensions, modifications, terminations), as well as lease and non-lease components (e.g., base/initial rent, variable payments, other fees such as CAM or taxes and insurance). Your entire schedule will need to be rebuilt when a modification occurs.

Plan to spend time developing required disclosure reports and tracking how your information will be sourced—be prepared to help your auditors tick and tie your schedules to prove out reporting accuracy (e.g., lease schedules, reconciliation reports, disclosure reports, etc.).

A technology solution can help centralize all leases onto a single platform, perform calculations, assist with lease administration and provide necessary information for reporting. Here are some of the critical benefits of using a software solution:

1. Calculate Future Lease Liability

An embedded solution means tracking and automation are built into your core financial system so no integrations or reconciliations are necessary

2. Calculate the Right of Use (ROU) Asset and Amortization

Your ROU balance will need to be adjusted for initial direct costs, incentives and pre-payments. Amortization will differ between operating and finance leases.

3. Separate Lease & Non-Lease Components

Contract terms may include non-lease costs, such as property taxes. Although paid together, they must be accounted for separately.

4. Track Terms Including Renewals, Options, Expirations, etc.

Relevant contract terms can be stored within the system and notifications can be generated automatically, ensuring that you never miss a key date.

5. More Comprehensive Disclosure Reporting

With all your data in a unified system, you can consolidate and disclose information about your entire lease population with one click. A few of the new disclosures include lease costs, weighted average discount rate, weighted average term, incremental borrowing rate and un-discounted lease maturities.

Store, track and report on key information including contract provisions, maintenance schedules, units and usage. Controls can be established throughout the lease lifecycle.

Lease accounting software has become much more affordable as a multitude of lease solution providers compete for new, price-sensitive customers. Because lease solution providers charge based on the number of leases, the cost for companies with fewer leases can be surprisingly affordable.

In addition to reducing your compliance risk, the time saved as a result of automating your lease accounting can easily offset the software cost. Several of the largest CPA firms have found that companies can realize a positive ROI with only a few leases.

It can be difficult to choose the right accounting software for your business. This guide can help you determine your needs and what kinds of solutions are best for you.

When making this decision, it’s important to list and understand your primary and secondary needs. Consider features like compliance with the new accounting standards, ability to handle capital projects, real estate & lease management, asset maintenance tracking and facilities and space utilization.

Lease accounting software comes in a few more categories. Here are the two major decisions you need to make when considering the types of software available:

Lease accounting solutions are focused on generating the proper journal entries for leases. They are typically built based on guidance from Certified Public Accountants and are primarily focused on compliance with the new accounting standards—ASC 842, IFRS 16 and GASB 87. They also provide financial and disclosure reports to help you comply with the standard. Managing the non-financial aspects of your leases is a secondary consideration.

Lease management software, on the other hand, is first and foremost focused on the real estate, contract management, and lease efficiency side of things. They are generally older software solutions developed by non-accounting, real estate, or equipment industry experts. Accounting under the new standards is a secondary concern. If compliance with new standards is a primary requirement of yours, be wary of lease management solutions.

An embedded solution is built straight into your ERP system and therefore requires no extra integration. A native offering allows you to book journal entries directly to the general ledger and maintain all information in one centralized system. This helps avoid the dreaded reconciliation between AP and an outside system. Because an embedded solution allows your business to manage everything in one solution, there’s less maintenance and risk, less opportunity for downtime and no threat of broken integrations.

Standalone solutions, on the other hand, are built completely outside of your ERP system and require additional integrations or manual uploads to book entries to the general ledger. On at least a monthly basis, you will need to reconcile your AP transactions with the data provided by the standalone solution. This can not only be time-consuming, but it can also produce errors and necessitate re-work during month-end close.

At the core of everything in business is the financial system. Within that financial system lies all manner of business operations — HR, CRM, billing, tax, inventory, etc.. Having those groups connected to the financial core with an embedded solution and a unified single database can save time, money and potential frustration.

For years, many organizations adopted the notion that “best-of-breed” third-party solutions were the answer. The reasoning stood that while ERPs might be able to offer a wide-reaching solution to help most corporate departments function, these solutions weren’t ideal for handling the more nuanced and specific needs of any one department. So, organizations began adding lots of third-party solutions, each one bringing with it a layer of complexity and cost — not to mention an ever-expansive spaghetti chart.

Now, times are changing. CFOs have grown frustrated with third-party solutions and the associated costs, complications and increased risk to business management. Additionally, auditing becomes more complex and costly because auditors are forced to learn third-party solutions. Many of these issues aren’t factored in when choosing “best-of-breed” solutions, leading to added costs and frustration down the road. For good reason, many CFOs are on a mission to reduce the number of third-party integrations and subledgers in their organizations. Embedded solutions are bringing secure, efficient and cost-effective ways of managing a multitude of corporate departments and functions. And because embedded solutions work seamlessly within a vetted and proven ERP, it makes management easier for IT. And that makes IT happy.

Managing your leases in a native solution can help your organization in so many ways. Achieve greater efficiency and increased security. Streamline systems and processes with a single database. Reduce complexity, lower costs, save time and eliminate frustrations. And according to experts, embedded solutions help users unlock operational efficiency increases by a factor of seventeen.

Learn more about the benefits of an embedded system here.

Picking the right lease accounting software can be daunting. Most solutions have strong and weak points. Here are some tactics to more effectively and confidently select your lease accounting software.

Software solutions excel in some areas more than others so it’s important to identify your primary, secondary and “nice-to-have” requirements. Create a scorecard that lists your required features and assign weight to each feature based on your priorities (see the example below).

Based on the needs identified in step one, create a short list of solutions that may meet those requirements. Consider vendor solutions, an existing solution provided within your ERP software, Excel and homegrown programming as possible options.

Rate each vendor based on the answers to the above questions. In our basic example below, we’re rating two vendors based on four main categories – accounting and compliance, ease of use and implementation, software infrastructure and lease and contract management. Multiply each score by the associated weight percentage created in Step 2 to get category scores based on priority and sum the results. These scores can help you make an informed decision.

Here’s a simplified example scorecard to help identify the right lease accounting software:

At this point, you know what vendor’s functionality aligns best with your business priorities. However, we live in the real world and budgets must always be a major consideration when adopting new processes. Assess each vendor based on the value they bring and ensure you have adequate functionality in your budget.

Understand the level and kind of support you’ll get from your vendor (including the upgrade process/cadence and support team reliability) before making a decision. Your vendor should have a dedicated support team with the capacity to assist you during implementation and beyond. Also, understand the upgrade process. Is there a history of upgrades affecting the current-state accounting of live customers? How often and in what manner are system upgrades deployed?

By now, you have a good understanding of how the new lease accounting standards have changed, the benefits of a software solution and the key differences between solutions. You’ve seen the numerous benefits of an embedded system. The question now becomes: which embedded solution do I want?

NetLease, the lease accounting solution from Netgain, has the features you need with support you can rely on. It’s compliant with the ASC 842, IFRS 16 & GASB 87 requirements, easy to set up and combines reporting with outstanding predictive tools. In short, NetLease covers all the new complexity of lease accounting in a simple but powerful solution.