5 Mistakes to Avoid When Implementing the New Lease Standard


5 Mistakes to Avoid When Implementing the New Lease Standard

The new lease standard is more complicated than companies expect and therefore often underestimated. Because of this, we are seeing some unfortunate trends as the new lease standard is implemented. Read on for the top five mistakes we’re seeing to avoid these challenges for your organization.

Allow sufficient time to analyze real estate leases

Office space and other real estate leases are often the largest dollar value and most complex leases within an organization, so you should allow plenty of time to analyze these leases. If you are interested in minimizing your lease liability and you have nonlease components included in your lease contract, you will also have to do some work to calculate the breakout between lease and nonlease components before recording the right-of-use asset and lease liability on your books. In fact, common area maintenance has its own set of factors that need to be carefully considered for office space leases.

You must also be careful to get the lease term correct. Based on what you know now about your organization, how long are you reasonably certain to remain in that space? Missing a renewal term can result in a material misstatement on your balance sheet.

 

It’s all leases, people

One of the first and most common questions we receive after we offer a training session on the new lease standard is, “But wait, is my {insert anything} lease included in this standard?” It might be a vehicle, piece of equipment, or land and, whichever it is, my response is a resounding, “Yes.”

The standard offers you the ability to elect a practical expedient to exempt leases that are less than 12 months. Other than that, there is no explicit exemption for any lease type, nor is there any explicit allowance for materiality under ASC 842. The international standard, IFRS 16, does allow for the exclusion of leases under $5,000.

In other words, if you have a contract that meets the definition of a lease, it must now be recorded on the balance sheet.

 

Watch out for hidden leases

Because the definition of a lease has changed, there’s now the concept of an embedded lease that also must be recorded on the balance sheet. Many organizations are unaware that certain service, outsourcing, and other contracts must now be analyzed for assets that could be classified as a lease.

A service contract requiring an outside vendor to use equipment on your behalf does not automatically result in an embedded lease. That determination is driven by the importance of the equipment to the overall delivery of the service. If the vendor dedicates equipment to your specific production needs, then you might have an embedded lease. If the vendor transports items for you and specific vehicles are dedicated to your organization, you also might have an embedded lease. You must understand—and document—the underlying nature of the arrangement in order to determine if you have an embedded lease.   

For further information on embedded leases, you may find these resources from PwC and Deloitte helpful.

 

Wait, how long will it take to implement this standard?

I’m not going to beat around the bush here: we are hearing that implementing the new lease standard is taking about three times longer than expected and therefore costing three times as much. Please see our post for more information on how and when implementations should be started.

 

It’s just leases—is there an impact on my business?

The largest business impact we’ve seen is on banking relationships. For any organization that has to comply with covenants for a bank loan, adding a significant liability to the books can affect how a bank considers credit availability and borrowing rates.

You might be thinking, “Yes, but that lease liability was part of my organization all along. Why would this change anything?” You’d be correct: your organization hasn’t changed with the implementation of a new lease accounting standard.

At the same time, your financial institution will now have more information about your lease portfolio and we’ve been told by some banks that this could be an opportunity for them to adjust relationships with certain clients. We’ve also been told by those banks that early communication about the impact of the coming lease standard on the financial statements is the best way to mitigate any effect it might have on the banking relationship.

 

Need some help implementing the new lease standard with your clients? Check out our free guides and tools, or get in touch to learn about LeaseCrunch, our lease accounting software that vastly simplifies implementation of the new standard.

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