The Road to Lease Accounting Implementation: Practical Tips and Strategies to Ensure You’re Compliant

Introduction to Lease Accounting

• Various rules: ASC 842, IFRS 16, GASB 87
• Balance sheet recognition of right-of-use assets and lease liabilities
• Immediate decrease in reported working capital
• Financial ratio changes may impact debt compliance and other financial covenants/requirements
• Required for public companies 1/1/2019 and for private companies 1/1/2022 (COVID-19 delay)

Leases overview

• Accounting definition of a lease
• Lease classification – 5 criteria - finance vs. operating
• Embedded leases
• Key accounting concepts
  • Recognizing right-of-use asset and lease liability
  • Lease component vs. non-lease component
  • Fixed payments vs. variable payments
  • Lease commencement vs. payment commencement
  • Existing accounting under ASC 840 carries forward – assuming it is correct
  • Can apply going forward – no impact to equity, no restatement of prior reporting
  • Can exclude short-term leases 

Key decisions and implementation issues

• Transition method, reassessment practical expedient package, short-term leases, hindsight
• Election to not separate non-lease components (and treat as one combined lease component)
• Determining lease term – “reasonably certain” exercise of renewal/extension/ termination options
• Determining discount rate – incremental borrowing rate, rate implicit in the lease
• Determining lease payments – fixed payments, rent increases, index-based increases, variable rent, rent holiday considerations
• Leasehold/tenant improvements – who pays and who benefits
• Previous deferred/prepaid rent
• Amendments and remeasurements

Lessons Learned from Public Company Implementations

• More complex than initially envisioned
• Takes longer than initially envisioned
• More stakeholders involved than initially envisioned
• Obtaining and analyzing data is the key
• Technology solution is not the driver
• Process changes needed to establish appropriate controls (identification, recording, reporting)

Current Developments and Opportunities

• Centralization of lease documentation
• Careful drafting of lease documents can address potential implementation/compliance issues (and reduce future accounting and auditing costs)
• Pandemic-related changes to lease arrangements/contracts – may include contract modifications
• Sale and leaseback transactions
  • Can provide working capital for other strategic business purposes
  • If “successful for accounting purposes,” can result in gain recognition if the following are met:
    • Must meet the transfer of control requirements of ASC 606
    • Leaseback must be classified as an operating lease
    • No repurchase option unless for fair value at the time and there are other “substantially the same” assets available (excludes real estate)
  • Treated as a financing if “not successful for accounting purposes”
• Following successful implementation, focus on establishing processes and controls that are reliable, repeatable, sustainable, and scalable

Closing thoughts

• Provide enough time (often 9 – 12 months) and remain flexible
• Enlist the support of professionals and assemble a team with the needed talent and experience
• Manage the project, monitor progress, and see through to completion
• Assess lessons learned for establishment of post-implementation compliance processes and controls