Businesses must follow new accounting rules when it comes to recording leases. New changes require that publicly traded companies record leases as assets and liabilities on balance sheets.
Getting Up to Speed: Revised Accounting Standards
Revised standards are based on rule 842 of Accounting Standards and IAS 16, per the International Accounting Standards rules. These changes took effect in January 2019, or the fiscal year that began in that year.
While capital (“finance”) leases were previously recorded on balance sheets – as a liability and a fixed asset, the changes apply to operating leases, or lease agreements that are more typical of rental contracts.
What the Changes Cover
Changes now require companies to include operating leases that are 12 months or more in length – in terms of assets and liabilities. This change in accounting refers to lessees who plan to return an asset to the lessor. Both tangible property, or property, plant, and equipment (PP&E) and real estate, are included. Intangibles are not added in the updates.
More precisely, the new accounting standards represent a notable change for businesses that operate in the spaces of technology, media, and telecommunications, or TMT.
However, the changes do present a more transparent view to both investors and stakeholders alike. In some cases, a business may need to upgrade its accounting technologies.
The Impact on Telecommunication Companies
As you might imagine, this added workload will give many telecommunication companies pause for thought. Not only will they have to address questions on real estate and towers, they’ll also have to account for items such as set-top boxes, fiber networks, and hardware.
Changes for Media Businesses
Media companies also face similar challenges, with accounting changes leading to questions on the receipt of services and the use of assets for ad media content. This may include the use of web properties or billboards, or, specifically, the identification of certain assets and their related economic benefits.
In the technology space as well as other industries, the rise of cloud computing, for example, prompts major inquiries on ownership, services, and leases. For instance, you might wonder if a specific server is set up for a client’s use. Or is the use more implicit? Needless to say, if you’re an accountant or manager, the changes will give you a lot to consider.
Your answers will hinge on both your insights as well as ongoing reviews and online research.
Reviewing Your Lease Portfolio
To navigate the changes involved with lease accounting, you’ll need to scrutinize your current lease portfolio. This entails identifying the leases you currently have in your inventory and gathering the required documents. Doing so will help you better understand the lease terms, conditions, and financial implications for the contracts.
By taking this step, you’ll create a more organized foundation – a foundation that will help you manage your lease accounting steps so you can make management decisions and system updates more easily.
Using Lease Accounting Software
To make sure all changes are handled correctly, you’ll need to implement software for your lease accounting contracts. This software will streamline the data flow by collecting the information and calculating the numbers. When choosing a software for this purpose, you’ll need to consider the following:
- The software’s compatibility with with your current software systems
- Ease of use
- Customer support
Revising Policies and Processes
With new lease accounting practices in place, you’ll also need to assess your internal processes and policies. This is necessary to remain compliant.
It’s also important to provide training to your employees on new policies and procedures. In addition, it’s essential to stay updated on the current lease accounting landscape.You can do this by joining accounting organizations and regularly consulting with your accountant.
Changes in Lease Accounting: FAQs
Changes in lease accounting can be confusing. Therefore, it’s important to demystify some of the changes so you’ll know how to proceed. The following FAQs can help you navigate the new standards so things will make more sense.
How Do the Changes Affect Leases Specifically?
Current standards, as mentioned, apply to leases 12 months or more in duration. If you have leases that last less than 12 months or leases that feature low-value assets, they are exempt. Therefore, they do not need to be included on the balance sheet..
How Do the Changes Impact Reporting?
Changes for lease accounting make it mandatory to report leases on a balance sheet by recognizing “right-of-use” assets and lease liabilities. This is different from prior GAAP standards – rules that only covered capital or “finance” leases. As noted, currently, both operating and “finance” leases are listed and recorded on the balance sheet.
How About Financial Ratios?
When you include lease assets and liabilities to a balance sheet, it may negatively impact certain financial ratios. For instance, debt-to-equity ratios will increase for most businesses. Therefore, investors and lenders may need to make adjustments when analyzing data to account for these results.
Do the Changes Alter How Leases are Categorized and Defined?
No. Leases are still categorized as “finance” or operating leases by the lessee. Therefore, the criteria for a lease’s designation basically remains unchanged. Lessors typically define leases as sales-type leases, direct financing agreements, or operating lease contracts.
What Steps Should I Take to Manage Lease Operating Changes
You’ll need to take the following steps to manage lease operating changes effectively and proficiently.
- Review your leases to see which ones meet the definition of a finance lease under the updated standards. These leases should be recorded on your balance sheet from here on out.
- Compare the terms of each lease. For example, you may need to check if the terms cover the main part of an asset’s remaining economic life.
- Write and add new policies and processes so you can identify the accounting for your leases accordingly. Consider the new disclosure requirements, as you’ll need to include more lease details on the balance sheet.
- Review your lease management software needs and what upgrades you may need to make. Some businesses implement dedicated lease accounting systems so you can remain compliant. This may include customization.
- Speak to an accounting advisor or software consultant about determining best practices. Doing so can help you identify areas of risk or uncertainty, or assist you in optimizing your processes. This will also help you make a smooth transition.
You’ve Got This!
You can navigate lease accounting changes while ensuring ongoing compliance. Keep learning about your options, stay updated, and ask for professional assistance when needed.