CHAPTER 1: EVERYTHING YOU NEED TO KNOW
The new lease standard (ASC 842 in the U.S. and IFRS 16 internationally) is intended to account for all lease obligations on financial statements, rather than excluding operating leases as has been the standard. This change ensures that a company’s financial situation is reflected as accurately as possible within the financial statements.
With the new standard, all leases must appear on the balance sheet as a Right of Use (ROU) Asset and Lease Liability.
Grab this quick reference guide now to provide a summary of key points to your clients.
Public and international companies must begin using the new lease accounting standard during their fiscal year that occurs after Dec. 15, 2018. Non-public organizations must comply for their fiscal year after Dec. 15, 2019.
UPDATE ON APRIL 8, 2020
FASB proposed to delay the deadline one year for non-public companies, which would make the new effective date the fiscal year starting after Dec. 15, 2021.
Why the change?
Under the previous lease standard, ASC 840, payment obligations of “operating” leases are not reflected on the balance sheet even if you have committed to many years of payments. In other words, there is a future debt (a liability) that is nearly invisible on financial statements. Those payments are mentioned in the footnotes, but not prominently among other liabilities on the balance sheet.
Many organizations have dozens, or even hundreds, of operating leases, which can result in a huge gap for anyone trying to understand that company’s financial situation via their balance sheets. This is why FASB made the change.
Download the New Lease Standard Quick Reference Guide today!
Because this is a judgment-based standard, judgment is often required to determine whether a contract qualifies as a lease under the new standard (this makes it an excellent area to add value for your clients). Use the following guidelines to determine what qualifies as a lease:
- It must be a physical asset.
- You must have the right to control or use the asset.
- The asset must be explicitly or implicitly identified.
Examples of leases include (but are not exclusive to) rental of office space, photocopiers, computers and servers, vehicles, land, and equipment. Examples of what are not typically considered leases under this standard include software subscriptions, leases for intangible assets, leases for exploration or use of non-renewable resources, and leases of inventory or assets under construction.
It’s also important to note that not all costs related to a lease are included in the leased asset and liability, so part of determining exactly what is a lease will be separating lease and nonlease components. There is no hard and fast rule, as the new lease standard requires quite a bit of judgment, but the key is thinking about the intent of a particular payment. Common items that are likely to be nonlease components include common area maintenance and service contracts for the leased asset.
When reviewing lease contracts, it is also important to determine if there are multiple lease components and, if so, whether those components need to be tracked as separate leases on your books, perhaps because they are designed to function separately or they have significantly different economic lives to evaluate. Don't forget to take advantage of the portfolio exception, where separate assets have such similar terms and characteristics that they can be combined into a single lease for reporting purposes.
Impact of the new lease accounting standard
As you’d expect, implementing the new lease standard means you and your clients will change how you think about and account for individual leases. There are a few additional considerations to keep in mind as well.
Changing accounting methods doesn’t change an organization, but it can affect the way financial results are viewed by outside parties. In particular, adding significant lease liabilities can impact compliance with debt covenants. It’s critical that your clients get a handle on the potential impact and start conversations with their bank as early as possible.
The new lease standard requires organizations to make policy decisions about how they will handle leases. Many of these policies make implementation easier but often will result in a larger liability and asset on the books. Early on, your clients need to review and decide which policies are right for their organization.
Process and controls
In most organizations, operating lease decisions have been fairly decentralized, especially when multiple locations are involved. The new lease standard requires these decisions to be centrally documented and available for accounting, which introduces a need for new systems, processes, and controls. The good news is that organizations are often finding efficiencies and cost savings with this new approach.
CHAPTER 2: NEW LEASE STANDARD IMPLEMENTATION TIMELINE
The new lease standard is effective for fiscal years starting after December 15, 2018 for public entities and after December 15, 2019 for all other organizations. [Update: On April 8, 2020, FASB proposed to delay implementing the new lease standard for non-public organizations, making their new effective date the fiscal year starting after Dec. 15, 2021. The announcement comes after a previous delay on Oct. 16, 2019 to making their new effective date the fiscal year starting after Dec. 15, 2020, which is still in effect for public non-profits.]
Once you know your effective date, you can determine your Initial Application Date, which is an important date that we describe in more detail at the end of this piece, along with definitions of other key dates for the new lease standard.
How do you implement the new lease accounting standard? For a checklist of key steps in the implementation process, download “Are You Ready for the New Lease Accounting Standard?”
Wondering how prepared your organization is for the new standard? Take this quick readiness assessment to find out!
Many companies find that identifying and analyzing their leases requires more resources and expertise than they have available. Don’t underestimate the requirements for this initial step. In fact, you may want to consider engaging outside advisors from the start to avoid errors and higher costs after implementation.
When you are ready to implement the new lease standard, you need to determine when to start each step and what resources are required. To help you with your planning efforts, we have prepared a matrix with related timelines so you know when you need to begin your implementation efforts to leave sufficient time for completion before your Initial Application Date.
In our new lease standard implementation matrix, we have created the following groupings by number of leases in the portfolio:
Small: 1 – 100 leases
Medium: 100 – 2000 leases
Large: Over 2000 leases
Grab this checklist to help clients prepare to implement the new lease standard!
By using this chart, you can estimate how many months you may need for each of the major implementation categories based on your lease population. You can create a timeline of key dates for the new lease standard tailored to your company that will help you to plan and monitor your progress.
UPDATE AS OF April 8, 2020:
FASB proposed to delay the effective date one year for private companies. This chart has been updated to reflect that change.
For purposes of this matrix, we treated all types of leases the same, using a common guideline that each lease will take about three hours to analyze (for more information on the time it will take to analyze leases, see page 37 of this KPMG Presentation). For your planning, consider the complexity of your contracts as well as how many people can dedicate their time to reviewing your leases. If you have 50 reasonably straightforward leases, it might take one person less than a month’s dedicated time to analyze them. However, if there are 40 straightforward leases and 10 complicated ones, you might need to extend your preparation time by a month or more to allow for the proper conversations and decisions to occur.
Also, your project team’s familiarity with the new lease standard can impact the time that this will take. Companies should expect more time to review leases initially because the team is adjusting to new definitions, processes, systems, and decision considerations.
You will notice that we have overlapped the timing of most implementation stages. Depending on your resources, your timeline may be linear - starting at a point in time and adding all the numbers of months in the steps sequentially. As a result, your overall timeline could be longer.
Using the outcome of this simple analysis, you will have a better indication of how many months before your IAD you must get started to be ready in time. If you find that you do not have sufficient time with your existing planned resources, you may need to involve additional internal resources and/or hire consultants to help you. Many organizations are already planning to outsource components of the new lease standard implementation and it may be the only way to meet your deadlines.
Key Dates in the New Lease Standard
The Effective Date is the end of the fiscal year for which you elect to adopt the new lease standard. For example, if you decide to adopt the new lease standard early for your fiscal year ending 2020 and your fiscal year-end is September 30, then your Effective Date is September 30, 2020.
The following organizations have already adopted the new lease accounting standard as of December 15, 2018:
- All organizations following IFRS
- Public business entities
- Not-for-profits with conduit bonds that are openly traded
- Employee benefit plans that files financial statements with the SEC.
For example, if you are a publicly held company and your fiscal year end is December 31, then your Effective Date is December 31, 2020.
For public non-profits, the effective date is fiscal years beginning after December 15, 2020. For non-public organizations, the effective date is fiscal years beginning after December 15, 2021. For example, if you are a privately held company with a fiscal year end of March 31, your Effective Date is March 31, 2021.
Initial Application Date
Now that you know your Effective Date, you can determine your Initial Application Date. Following the original guidance, this would be the first day of the first fiscal year represented in your financial statements.
For example, if your Effective Date is December 31, 2020 and you have three comparative years in your financial reports, your Initial Application Date is January 1, 2018.
If your Effective Date is March 31, 2022 and you have two comparative years in your financial reports, your Initial Application Date is April 1, 2020.
It is important to note that the FASB recognized that the above guidance requires restating prior years and therefore is a significant amount of work. Therefore, they issued ASU 2018-11 in July 2018, which allows companies to avoid prior-year restatement. Most organizations do elect this new practical expedient. For more information about this, please see our blog post: "FASB Amends the New Lease Standard."
- Using the above example, if your Effective Date is December 31, 2020, you have three comparative years in your financial reports, and you elect the new transition option, your Initial Application Date is January 1, 2020.
- If your Effective Date is March 31, 2022 and you have two comparative years in your financial reports, and you elect the new transition option, your Initial Application Date is April 1, 2021.
Why do you care about the Initial Application Date? Because the time between your Initial Application Date and the Effective Date is called the Transition Period. During this time, you don’t quite follow the old standards nor do you completely move to the new standards.
While this is fairly complicated to figure out, the good news is that there are practical expedients available to simplify the work required during the transition period, particularly around whether or not the lessee needs to reassess expired or existing leases, as well as the ability to use hindsight on renewal and purchase options.
Important Dates for Individual Leases
An important date for individual leases is the Commencement Date, which is the date the underlying asset is available for use by the lessee. It’s important to note that this may not be the date when the lessee enters into the agreement with a lessor. Lease classification and measurement should take place at the commencement date.
Modification Effective Date
Sometimes leases are renegotiated. If this results in a new contract, renewal, or other extension not previously anticipated, it is treated as a new lease. Otherwise, assumptions such as the discount rate, fair value, and remaining economic life of the underlying asset are reviewed and updated as of the Modification Effective Date, with modification gains and losses also recognized as of the same date.
Other times, a triggering event occurs that was not otherwise anticipated. Generally, this is something that requires the lessee to reassess the lease term. The date as of which this triggering event occurs is called the Remeasurement Date. Note that the lessee should also update the discount rate and any variable lease payments as of the Remeasurement Date.
CHAPTER 3: LEASE AUDIT HOW-TO + CHECKLIST
A critical part of implementing the new lease accounting standard is reviewing existing contracts, determining what does and doesn’t qualify as a lease, and creating initial journal entries to apply the standard to the balance sheet.
This article examines what you need to know about what does and doesn’t qualify as a lease, separating lease components, making policy elections, and auditing leases.
Pressed for time? Download the Lease Audit Checklists for Office Space and Vehicle Leases now to get started.
Download the full Lease Audit checklists today!
Understand what qualifies as a lease
Before reviewing your portfolio of contracts, it’s important to understand exactly what qualifies as a lease under the new lease standard. Under the new lease standard, all leases must be recognized as both an asset and offsetting liability for future lease payments. This is a big difference from the previous standard, where operating leases were not reflected on the balance sheet. There are a few considerations that help determine if a particular contract is a lease:
One key to knowing that you have a lease rather than another type of contract is whether you have the right to control or use an asset. Additionally, the asset itself must be explicitly or implicitly identified, as well as be physically distinct. Also keep in mind that some leases are actually being leased as part of that vendor contract.
Identifying embedded leases
An organization has an embedded lease when there is a contract with a vendor that uses an asset as part of the value provided and the use of that asset meets the definition of a lease. A contract may contain a lease even if it's a service contract. To properly implement the new lease standard, organizations should review every contract to ensure all leases, regardless of labeling, are properly included in the financial statements.
According to 842-10-15-3: A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. A period of time may be described in terms of the amount of use of an identified asset (for example, the number of production units that an item of equipment will be used to produce).
The Embedded Lease Identifier is an excellent free tool to make identifying potential embedded leases within contracts vastly simpler and quicker over doing so manually.
With any rule, there are always exceptions. For example, the leasing standard does not require lessees to apply the guidance to leases with a term of 12 months or less. Additionally, there are certain leasing scenarios that exempt the lease from consideration, including:
- Leases of intangible assets (e.g., goodwill, etc)
- Leases to explore or use non-renewable resources (e.g., oil, natural gas, etc)
- Leases of biological assets (e.g., timber, livestock, etc)
- Leases of inventory or assets under construction
- If you comply with the IFRS standards, you may elect to not apply the new lease standard if the underlying asset is of low value.
Separating lease and nonlease components
Not all costs related to a lease are included in the leased asset and liability. For example, a lessor may lease a truck and also include a provision to operate the truck on behalf of the lessee. Providing a driver, maintenance, and gas are not related to securing the use of the truck and these costs would be considered nonlease components.
On the other hand, costs attributable to securing the asset itself should be included in the lease payments for both classifying and measuring the lease. For example, a non-refundable upfront deposit would be considered a lease component.
A hallmark of ASC 842 is that it requires quite a bit of judgment. This means you need to think about the intent of a particular payment to determine whether it should be included or excluded. This is a good starting place when considering how to classify lease-related payments.
Likely to be
Likely to be Nonlease Components
Not Likely to be Lease or Nonlease Components
Help clients make the right policy elections
A critical part of implementing the new lease standard, including auditing leases, is making the required policy elections, summarized below.
Lessees may make a policy election not to apply the standard (that is, not recognize a right of use asset or lease liability) to short-term leases of 12 months or less for all classes of underlying assets. If this election is made, the lessee would recognize the lease payments as operating expenses straight-line over the lease term. This election saves time in accounting for these leases, but the disadvantage is that different accounting policies and processes need to be in place for short-term and long-term leases.
A lessee may choose, as a practical expedient by class of underlying asset, to account for the lease and nonlease components as a single combined lease component. If this election is not made, the lease payments are allocated to the separate lease and nonlease components, using relative standalone prices (estimated if not readily available). While this expedient saves time, the lessee will have a larger liability (and ROU asset) by treating nonlease components as lease components.
At the lease commencement date, lessees determine the present value of the lease payments to calculate the ROU asset and lease liability using the rate implicit in the lease. If the rate implicit in the lease is not readily available, nonpublic business entities can make a policy election to use the risk-free rate in lieu of determining an incremental borrowing rate. This election saves time and reduces audit risk; however, the risk-free rate will likely be a lower rate than the incremental borrowing rate, creating a larger lease liability.
If any of the five criteria in ASC 842-10-25-2 were met, a lessee would classify the lease as a finance lease. One of these evaluation criteria is whether the lease term is for a major part of the economic life of the underlying asset. Lessees can make a policy election, by class of asset, to define what percentage constitutes a major part. Although the FASB did not include a bright-line percentage in ASC 842 as in prior guidance, it has indicated that 75% of the asset’s remaining economic life is a reasonable approach.
Another of the five evaluation criteria is to determine whether the present value of the sum of the lease payments equals or exceeds substantially all of the fair value of the underlying asset. Lessees can make a policy election, by class of asset, to define what percentage substantially constitutes “all.” Although the FASB did not include a bright-line percentage in ASC 842 as in prior guidance, it has indicated that 90% of the fair value of the underlying asset is a reasonable approach. The advantage of defining the major part and substantially all using 75% and 90% respectively, is consistent accounting application across the lease portfolio.
Presentation of ROU assets and lease liabilities
Lessees can make a policy election on how to present their finance and operating lease ROU assets and lease liabilities in their statements of financial position and related footnotes. They can elect to present a separate statement of financial position line items for finance lease ROU assets, operating lease ROU assets, finance lease liabilities, and operating lease liabilities. Or they can disclose in the footnotes, where each of these types of assets and liabilities has been included in the financial statement line items. If leases are not significant, clients may find disclosure in the footnotes to be a better election.
A number of practical expedients are available for lessees to apply to leases that commenced before the standard’s effective date. Each practical expedient must be elected as a package and applied to all leases. Lessees can elect not to assess whether expired or existing contracts are or contain leases, lease classification for any existing or expired leases, and whether initial direct costs would have qualified for capitalization for any existing leases.
Another expedient that can be elected for existing leases at transition is to use hindsight regarding lease renewals and purchase options when determining the lease term and in assessing impairment of the ROU asset. This relief can be elected independently of the previous practical expedient, but it must be applied consistently to all leases.
Lessees may apply a single discount rate to a portfolio of leases with reasonably similar characteristics (such as a similar lease term for a similar class of asset). A single discount rate cannot be applied to the entire lease portfolio.
In July 2018, the FASB issued an additional transition relief option for lessees, allowing entities to use the effective date of the new lease standard as their date of initial application. For example, the initial application date for most privately held companies with a calendar year-end is January 1, 2022 if this transition relief is elected. With this transition method, comparative prior years on the financial statements do not have to be restated.
Lease review checklist
Once it’s time to conduct an actual review of each lease, you’ll want to walk through a number of questions. Download free Office Space and Vehicle lease review checklists here to simplify the process.
- Determine if it is a lease for accounting purposes under the new lease standard, taking into consideration asset control and identification.
- Note general information about the lease, including name, description, lessor, lease terms, termination clauses, renewal options, discount rate, etc.
- Outline lease payment terms, including payment frequency, amount, start date, and other relevant details.
- Classify the lease correctly based on ownership, economic life, and fair value of the leased asset.
- Calculate variable and nonlease payments.
CHAPTER 4: IMPLEMENTING THE NEW LEASE STANDARD
Once an organization is done with policy elections, their lease audit, and other preparations, it’s time to actually implement the new lease standard. This chapter will focus on that process, including examples and best practices.
Transitioning leases under the new standard
How to capture on financial statements
Implementing the new lease standard requires transitioning all existing leases from ASC 840 to ASC 842 (or IAS 17 to IFRS 16). Here are the steps to help clients do so and capture them accurately on their financial statements:
- Practical expedients. Have clients consider their policy elections, particularly around the practical expedients that they decide to utilize. Those can dramatically ease the amount of work needed upon transition. Key practical expedients include:
- Initial Application Date: You can elect to apply the lease standard to only the most recent period without restating prior periods. If you choose this option and you report on two periods in your financial statements (for example, years that ended December 31, 2020 and 2021), your first entry occurs on January 1, 2021.
- The advantage of electing this practical expedient is that you do not need to restate prior periods. Of course, this does mean you will have inconsistent reporting on leases between the current and prior periods.
- Reassessing Leases: You can elect to not reassess three different lease factors:
- Whether expired or existing contracts contain leases
- The operating vs. capital (now finance) lease classification on existing or expired leases
- Whether initial direct costs for existing leases would have qualified for capitalization under the new lease accounting standard
- Use of Hindsight: You can elect to use hindsight on lease renewals and purchase options when determining the lease term, as well as hindsight in assessing impairment of an ROU asset.
- Discount Rate: You can elect to apply a single discount to a portfolio of leases with reasonably similar characteristics (such as a similar lease term for a similar class of underlying asset).
- Initial Application Date: You can elect to apply the lease standard to only the most recent period without restating prior periods. If you choose this option and you report on two periods in your financial statements (for example, years that ended December 31, 2020 and 2021), your first entry occurs on January 1, 2021.
- Lease liability. Calculate the present value of all future lease payments (monthly rents, including known escalators, residual value guarantees, excluding rent holidays) after the Initial Application Date. This is your lease liability.
- Right of use (ROU) asset. Starting with the lease liability, add or subtract balances on the balance sheet related to this lease. This might include deferred rent amounts, incentives received, or other initial direct costs calculated under ASC 840 or IAS 17.
- In general, this excludes leasehold improvements, the accounting for which remains relatively unchanged under the new lease standard.
- Book it! Record your asset and liability as of your Initial Application Date and you’re ready to go forward with the new lease standard.
- Equity Affected? We are accustomed to changes in accounting standards affecting equity as a Cumulative Effect on Change in Accounting Principle. Adopting the new lease standard will not affect equity for the most common types of leases. We’ve included a few examples below where equity can be affected.
- Initial Direct Costs. If your client chooses to reassess leases by not electing the practical expedient noted in 1(b) above, the definition of Initial Direct Costs has now changed and, as a result, their opening entry might affect equity.
- Hindsight for Impairment or Lease Term. If your client does elect the practical expedient to use hindsight on impairment or lease term of a leased asset, noted in 1(c) above, it may affect their equity.
- Operating Lease Transition under IFRS 16. Under IFRS 16, there are two options to determine the ROU Asset for what were operating leases. One option is consistent with ASC 842 and would not affect equity. Another option measures the ROU Asset as if IFRS 16 was applied at the lease commencement date. The journal entry for this option (including the new lease liability and removal of existing balances under IAS 17), would include an entry to equity.
- Other scenarios that could affect equity. Built-to-suit arrangements, currency translation differences, and sale-leaseback transactions can also affect equity.
Note: When evaluating the lease or renewal terms of a related party lease, apply the same logic you would for all leases. The FASB made clear that they were not going to ask accountants to try to determine the economic substance of a related party arrangement or how the lease compared to market terms.
Want to see side-by-side examples of transitioning leases under the new standard? Grab the guide.
The financial statement footnote disclosure is more complex under the new lease standard than it was in the past, with additional requirements for both quantitative and qualitative disclosures.
There are three categories of quantitative footnote disclosures:
- Lease expense: This refers to all the various lease expenses that must be accounted for, including amortization and interest for finance leases and straight-line expense for operating leases. In addition, short-term lease expenses, variable lease expenses, and sublease income may need to be included.
- Maturity analysis: Similar to ASC 840, undiscounted cash flow must be disclosed. ASC 842 adds the requirement to include the present value discount as well.
- Other information: Required disclosures that fit this category include sale-leaseback transactions, cash flows, new ROU assets, weighted average remaining lease term, and weighted average discount rate.
Qualitative footnote disclosures, on the other hand, are more judgment-based around the nature of a company’s lease arrangements and the level of detail to include. The following are required qualitative disclosures:
- Existing leases: You must disclose information about the nature of your leases, including description, terms and conditions, options to extend or terminate, and restrictions or covenants.
- Future leases: Any leases that haven’t begun, but will add significant ROU assets and lease liabilities to the books, need to be disclosed.
- Judgments: You must also provide information about any significant assumptions or judgments made in applying the new lease standard, such as how you determined whether contracts contained a lease or allocated lease and non-lease payments.
Spreadsheets vs. lease accounting software
Many companies do not have processes and systems today that will enable them to effectively manage all of their lease agreements under the new lease accounting standard. Spreadsheets may have worked in the past because accounting was a series of routine transactions with rent amounts generally set for the life of the lease and there were minimal financial statement disclosures.
This approach may not work going forward, however, when lease amounts are recorded on the balance sheet, primarily because of the challenges of extracting, organizing, and maintaining lease data at adoption and beyond. There is a need for different internal controls and better documentation for initial accounting and subsequent changes.
Spreadsheets are known to be risky. There are risks of errors with inputs, formulas, importing data, and using macros, along with access control, version control, and how the outputs are used.
Benefits of using lease accounting software rather than spreadsheets to implement the new lease standard
Spreadsheets are prone to errors. One input error or calculation formula error can result in incorrect journal entries. If outputs in an incorrect spreadsheet are used as inputs in other spreadsheets, the errors can compound. Spreadsheets do not have any built-in controls. They are often designed and maintained by individual users that are solely responsible for their accuracy and updating, so their quality depends on the skills and training of those users.
Lease accounting software is developed, programmed, tested, and regularly updated, which simplifies compliance with complex accounting calculations and reporting. Software functionality can validate formulas and ensure that all calculations and formulas are systematically and consistently applied.
Lease data entered once is available consistently across all functions and reports. These internal controls over accuracy are critical features for the implementation of the new lease standard.
It is difficult to ensure the security of spreadsheets. Spreadsheets are frequently printed out, photocopied, emailed to others, accessed through shared folders, and generally not safeguarded. Additionally, the data in spreadsheets is easily modified and not always protected. Password protection is generally on an all or nothing basis and does not provide different levels of user access.
As lease accounting becomes more central to financial reporting, there must be adequate controls over data security and disaster recovery that spreadsheets do not provide. Databases are designed to hold much more information than spreadsheets, which can be essential for companies with a large number of leases.
Spreadsheets are outside of accounting systems and, therefore, require manual entry into the systems. Manually entering lease data takes longer and is more prone to errors than an automated approach. Also, multiple versions and spreadsheets that are not tied to a unified data source can result in variances and errors that waste time and can create inaccurate financial results.
Software provides the ability to configure downloads of lease data that can then be uploaded into accounting systems. Lease data in an unstructured format (like in paper documents, or PDFs and JPEGs) has to be manually entered or abstracted and converted before it can be uploaded, but data in digital format is ready to be uploaded to a lease accounting database. System outputs of lease data are faster and more reliable.
EASE OF USE
In general, spreadsheets take longer to design and maintain and are less reliable than a software solution. The accounting team with responsibility for accounting and reporting will need to create new spreadsheets for lease accounting general ledger data entry, journal entries, notes to financial statements, and management reporting. They will need to have extensive training on the details of the new lease standard to design the form and functionality of these spreadsheets in compliance with the standard. Once created, spreadsheets will have to be checked for accuracy and updated for changes on an ongoing basis. Journal entries must be created using spreadsheet data, which has the potential for error.
Wizards, alerts, and tips within the software can assist the accounting team with their learning curve on the new lease standard’s requirements and provide ongoing reference tools once the standard is adopted. For example, the software can guide users through a series of questions to ensure that a lease is properly classified as finance or operating. The software also has built-in controls to ensure accurate lease data inputs and can instantly provide calculations for journal entries, required footnotes, and management reporting.
Spreadsheets can slow down the closing and reporting process. Significant human resources can be required for preparing, revising, correcting, and consolidating multiple spreadsheets across an organization. There is also a potential cost to the company of using disconnected spreadsheets for management reporting or producing inaccurate data for financial reporting.
The software can be deployed to give multiple users access at a reasonable cost without expensive updates. The use of software results in fewer processing errors, better data analysis, and economies of scale in handling additional lease transactions efficiently, all of which result in lower finance department operating costs and better reporting. Audit trails available in the software will improve the external audit process, with potential cost savings and better use of internal resources.
Modification accounting is a challenging new area under the new lease standard. Minor lease events, like changes in variable rents, assets changing location or cost center or being returned or bought out, all must be identified and accounted for. Even more challenging is accounting for modifications when an asset is impaired, like a piece of equipment breaking, or a lease is extended.
With spreadsheets, it is difficult to lock down the initial calculations and apply new lease inputs and calculations only on a go-forward basis as of the date a lease is re-measured, modified, or impaired. Depending on the size of the lease population, changes can happen daily as asset needs change.
How to choose the right lease accounting software
It is important to analyze your firm’s objectives and budget to make the right choice when evaluating lease accounting software. The selection process will take some thoughtful planning and research and you only want to go through the selection process once. Consider the following areas when shopping lease accounting software vendors.
- Accounting: Compliance with the new lease standard’s accounting and disclosure requirements is the first priority for any software selection. There may be both FASB (ASC 842) and IASB (IFRS 16) requirements to consider because even smaller clients might have to comply with both if they have international subsidiaries. Make sure your software options can handle lease amortization schedules, journal entries, footnote disclosures, policy elections, and other critical aspects of the new standard.
- Financial reporting: To handle the significant new financial statement lease disclosure requirements, look for software that can perform all required quantitative calculations. For ongoing management reporting, determine whether the software is flexible enough to report on different types of leases required. Reporting capabilities should include both standard and customizable reports.
- Lease functionality: To meet the needs of many different clients, consider whether the software can handle all lease types. If the software focuses on solving the problems of one industry, like real estate or equipment, make sure it can adequately address the needs of other asset types. Also look for the ability to attach lease documents and add notes to the lease record.
- Scalability: Your clients may have a small or a very large number of leases, and these numbers may change over time. Evaluate the software’s capabilities as it relates to the number of users and the size of the lease portfolio. Also, consider what the options are for the software to expand with the number of and type of leases.
- Accuracy: It is important to understand how data will be controlled and checked, and whether the software has built-in capabilities to ensure lease data is entered correctly, like validations and wizards, so the user has access to the right information exactly when they need it. The internal controls at the software provider are an important consideration, so ask whether a Service Organization Controls (SOC) report is in place or in process.
- Audits and reviews: Assess how the software can improve audit effectiveness and simplify quarterly reviews. If there are built-in audit trails and transparency into the software’s functionality, it will make your work on transition and day two accounting more efficient.
- Hardware and software: Ask vendors about the hardware and software associated with their solution, and how it can be integrated with your firm’s systems and your clients’ existing accounting and ERP system configurations. Understand the vendor’s ability to meet potential future needs, including software upgrades and bug fixes. Depending on your firm’s needs, determine if the vendor offers software as a service (SaaS), with anytime access from anywhere and no hosting requirements.
- Training and support: It is important to minimize the training required and to try to decrease learning curves. Evaluate how intuitive the software is to use, including whether users are provided with the information they need to accurately enter lease data and report on it. Ask whether any free training is provided to various user groups as part of the software implementation process, whether it is performed onsite or via online meetings, and whether additional training can be purchased later. Also determine whether there is ongoing technical support, a help desk for users, and whether there are also accounting experts available to assist.
- Independence: When assisting clients with the implementation of the new lease standard and ongoing accounting and reporting, independence must be maintained. Obtain an understanding of how the software has addressed CPA firms’ independence needs. If the vendor understands and has incorporated the requirements, they will be able to easily address your concerns about this important issue. Also consider whether the software can be ‘white-labeled’ for your clients.
- Data access and security: Depending on the size of the CPA firm and number of clients, how the lease data is input and accessed will impact transition and ease of use. Things to consider include whether both the CPA firm and clients can access the same data simultaneously, whether single sign-on capabilities are available to work within existing systems, and how new client data is added, such as whether bulk imports of lease data are possible. Data security is critical, so security protocols over client data should be understood and followed. Ask about the security standards and how security breaches are prevented and detected.
- Pricing: To evaluate and compare pricing across lease accounting vendors, discuss what implementation and other “add-on” charges will be included on initial and ongoing invoices. Some vendors may offer CPA firms pricing incentives for bringing new clients to the vendor’s software platform, so inquire about these or other available discounts.
Selecting the right software for the transition to the new lease standard is challenging. No system will likely meet every user’s needs, but you can use this Lease Accounting Software Buyer's Guide to assess your requirements and make an educated choice. Contact LeaseCrunch today to learn how we can support you as you evaluate which software is the best choice for your firm and your clients.
LeaseCrunch® provides a comprehensive, cloud-based software solution to help companies implement the new lease accounting standards. Built with the CPA firm in mind, LeaseCrunch is designed to accommodate the needs for companies with large, complex portfolios, while still being a cost-effective solution for companies with as few as 1-5 leases.