With the new lease accounting standards issued by FASB very soon set to become a reality, the corporate world has already started to take the necessary steps to become fully compliant under the new guidelines well ahead of the 2019 deadline. The new leasing standards requires most of the off-balance sheet leases to be represented as assets and liabilities on the balance sheet depending upon the right-of-use principle. With this, FASB expects not only the investors to have a true idea of the financial health of the company but also hopes that the management will get a better insight on the actual extent of their leasing liabilities which, in turn, will enable better decision making and capital allocation.
All new guidelines come with their fair share of challenges and the FASB new lease accounting standards is no exception – not to mention the associated costs in implementing such mandatory measures. Provisioning for such statutes becomes a prerequisite in such cases and the responsibility is on the organization to come up with additional sources of funds that will be needed to finance these mandatory requirements.
Through this article, we’ll explore how the new leasing standards impact an organization’s financial statements, the areas in which it might face budgeting challenges and the counteractive measures it can take to offset any kind of increase in its financial obligations.
While the new lease accounting standards ensures greater transparency for all stakeholders, FASB has made sure that the transition to the new update is relatively less complicated by letting companies use their existing business processes and systems. This is so because the treatment of operating leases in the Income Statement and Cash Flow Statement remain unchanged, which is similar to existing GAAP methodology.
The only change is to move them to the balance sheet and recognize a right-of-use asset and a lease liability. To fully understand the impact of the FASB lease accounting standards on the Balance Sheet, see the below illustration for how Operating leases greater than one year will need to be treated after these rules come into place.
Let’s assume the following:
Annual Lease Payment = $10000
Term of payment = 3
PV of payments = $26730
Discount Rate = 5%
Under the earlier methodology as an operating lease, the lessee would have made the following journal entry in his books of account.
Dr Lease Obligation 8663
Dr Lease Expense 10000
Cr Cash 10000
Cr Right-of-use asset 8663
But under the new lease classification the asset will be treated as a Finance lease and the lessee will recognize a right-of-use asset and a lease obligation of $26730. Also, he will have to recognize an amortization expense on the asset which will need to be done equally over the period of 3 years. That would mean, the yearly amortization value would be $8910. The journal entry for the same at the end of year 1 would be as follows:
Dr Lease Obligation 8663
Dr Interest Expense 1337
Dr Amortization Expense 8910
Cr Cash 10000
Cr Right-of-Use Asset 8910
The following table will further help in understanding the impact of the standard on the financial statements.
|Pre-FASB Lease Accounting Standards||Post FASB Lease Accounting Standards|
|Right-of-Use Asset||Lease Expense||Right-of-Use Asset||Interest Expense||Amortization Expense|
One significant financial challenge you might have to face as an organization is the costs of additional personnel to evaluate your lease portfolio. The new leasing standard requires a wide range of information such as lease commencement date, useful life, fair market value, borrowing rate, renewal/purchase options, any space changes during the lease term, landlord allowances, initial costs and impairment charges, if any and so on. With the new lease accounting standards expecting a detailed representation of your lease portfolio in the financial statements, there will be a need for additional resources to do a comprehensive re-evaluation of your lease assets.
It is also essential for the organization to educate and create awareness about the implications of the new reporting requirements – not just among the employees – but also the other stakeholders of the business including investors. You will have to invest in training resources as well as other awareness campaigns for the various stakeholders of the organization.
Compliance to mandatory requirements also involves additional costs like a significant increase in reporting burden as well as a probability of higher tax liabilities.
Modifications in the existing business process flow in relevant areas will also be needed to offset the increased costs of implementation of the new lease accounting standards. In your procurement process, you might have different contracts with different vendors for your leasing requirements. The pricing and terms of usage agreements might vary from one contract to another. But by dealing with a consolidated vendor team for instance, you can end up achieving economies of scale.
Similarly, you might want to revisit and renegotiate your leasing agreements for more favorable terms and in some cases, you can even re-examine your lease versus buy decisions by outweighing the costs and benefits of leasing.
What can be done?
More often than not, updating the IT infrastructure of the organization can be a better solution for most of the challenges posed by such mandatory requirements. An Integrated Workplace Management System (IWMS) software like IBM TRIRIGA can help resolve most of the issues relating to FASB new lease accounting standards implementation and what’s more, also result in cost savings in the long run.
IBM TRIRIGA can help an organization to better comply with the new lease accounting standards through the following ways.
- Cost and time-effective pre-configured workflows
- Providing Net Equity Impact reports along with finance and operating schedules to better analyze and manage the Balance Sheet impact
- Pre-configured templates to import lease data and accelerate data migration
- Integrate better and faster with financial systems with calculations aligned by fiscal period for efficient data exchange of journal entries
- Capture user actions and approval routing and effective integration of lease data
- Automatic alert generation on a company-defined basis to review lease accounting compliance
With such extending capabilities, IBM TRIRIGA can help you and your organization to not only achieve total FASB topic 842 compliance but also realize efficiency and cost savings in the long run.
Budgeting for FASB new lease accounting changes will be challenging but with the looming deadline you must prepare and learn. Where do you stand? Our next article “Why you’re late for the FASB Lease Accounting Game?“, helps you better plan your next move to meeting the FASB lease accounting deadline.
FastStart your way into the new lease accounting standards implementation with our IBM TRIRIGA experts at JLL and get benefited. For more information,
The JLL Team