Under the new standard (IFRS 16 /ASC 842) a lessee is required to recognize most leases on its balance sheet. This is a significant change from today’s accounting requirements which allows the lessee to exclude operating leases. In fact, listed companies around the world have around US$3.3 trillion worth of leases but under current accounting requirements, over 85% of these leases are not recorded on the balance sheet. (source)
The FASB & IASB standards do diverge in some instances – mainly in FASB’s decision to continue using two lease classifications – but both standards will help address the off-balance-sheet financing concerns operating leases currently pose. In defining the new standard, questions considered by the boards included:
- What makes an arrangement a service or a lease
- What amounts should be initially recorded on the lessee’s balance sheet for the arrangement
- How to reflect the effects of leases in the statement of comprehensive income of a lessee
- How to apply the resulting accounting in a cost-effective manner
The new standard retains much of the current lessor model but aligns certain of its underlying principles with those of the new revenue recognition standard (ASC 606).
Who is impacted?
While any company with operating leases will be affected, a recent Deloitte survey found the retail & distribution, automotive and telecommunication industries had the highest percentage of respondents express concern about complying with the standard.
According to Sean Torr, the director leading Deloitte Advisory’s efforts around the new lease standards, “those organizations facing the fastest compliance timeline are publicly traded and operating on a calendar fiscal year. Many are spending the balance of 2016 consolidating lease data so that calculations can begin in early 2017, as ultimate compliance with these new rules in 2019 will require look back reporting for 2017 and 2018.” (source)
How to prepare
Like any accounting standard change, organizational challenges include defining the people, process and technology requirements. This standard may be especially challenging given that all terms and data pertaining to leasing agreements are not readily (or even electronically) available in many companies. In a recent survey, PWC found that 68% of companies surveyed used spreadsheets as their primary system for tracking leases while 84% currently abstract key terms from their lease agreements manually. (source)
Organizations will also have to assess the volume and complexity of impacted leases and determine how to integrate all relevant information into one single, standardized platform. Once the required information is identified and data capture & storage requirements are understood, lease calculations will need to be defined and journalized with the results posted to the General Ledger and made available for reporting. Processes and technology must allow for amendments and adjustments all within a strong controls environment.
“Having a lot of leases or just a few complex leases in your portfolio can create management challenges. Other difficulties can arise due to disparate tracking systems, expanding global footprints and M&A activity,” said James Barker, national office senior consultation partner for Deloitte & Touche. (source)
Given the significance of the changes required, most advisors have urged their clients to begin conducting impact analyses to understand potential changes.
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