By Peter Brohoski, Senior Managing Director, Global Occupier Services
The lease accounting changes will have implications on and require changes to data management, technology, leasing policy, governance and financial reporting processes. The time to act is now.
What has happened?
Since the release of the new US GAAP and IFRS lease accounting standards in early 2016, most corporations have primarily focused on learning about new reporting requirements and key implications for real estate (and equipment) leasing.
As we progress through 2017, corporations are drastically shifting focus from education to mobilization asking the question, what steps need to be taken in order to comply with the new requirements by the first reporting period of 2019?
What you need to know:
- New lease accounting standards (US GAAP ASC 842 and IFRS 16) were released in early 2016.
- The rules go into effect in 2019 for public companies and 2020 for private organizations.
- These new rules apply only to companies that issue financial statements in accordance with US GAAP and/or IFRS (all public companies and certain private businesses.)
- The major provision of the new rules is that all leases (12 month or greater) will now be reported on the balance sheet. This is a significant shift from the current rules that allow most leases to remain off balance sheet.
US GAAP vs. IFRS – What’s the Concern?
Under the new lease accounting rules, all leases for tangible property are going on the balance sheet. While all companies will be affected by the impact on the balance sheet, the income statement treatment will vary depending whether the entity reports under US GAAP or IFRS.
Under US GAAP, the measuring of expenses (income statement impact) will utilize the dual reporting structure of operating leases and finance leases – the measurement of the P&L impact will be largely unchanged from the current rules. The expenses for operating leases will maintain a straight-line pattern, while expenses for finance leases (formerly known as capital leases) will maintain the interest-amortization declining pattern.
Under IFRS, all leases will impact earnings utilizing the interest-amortization declining pattern. This will have the effect of front-loading expenses for leases that were formerly treated as operating leases. Thus, the new rules will have a negative impact on earnings when first implemented for IFRS reporting entities.
What will the new lease accounting standards mean to corporate real estate executives? They need to realize that the accounting treatment of leases is changing and, consequently, leasing activities will be more closely monitored by the finance and accounting departments. Communication and coordination between these two functions will take on new importance.
Top 10 Ways Lease Accounting Changes Will Make An Impact On Your Clients
Transition Team: Corporate real estate managers will play a very large part in, or lead, preparedness efforts. This may require the formation of a transition team and the creation of schedules and milestones.
New Internal Governance: Internal governance structure may have to be adapted – corporate real estate managers will need to work closely with Legal, Treasury, Accounting and Finance departments.
Centralized Lease Database: Transitioning will require a significant implementation effort. Lease data will need to be airtight and more centrally controlled.
Lease Administration Software: Technology will be more important than ever! Lease administration systems, for example, will be vital to lease accounting compliance and on going reporting.
Equipment Leases: Corporate real estate managers may be asked to manage equipment leases. This could require a significant undertaking to locate and abstract equipment leases.
Lease Strategy: Portfolio planning and real estate decisions (e.g., Lease vs. Own) will be more complex. Lease strategy may require more lead-time; and greater scrutiny.
Streamlined CRE Processes: Real estate processes, procedures and technologies will have to be updated to capture relevant data, calculate financial statement balances, and to ensure that management has adequate control over the financial reporting process.
Playbook Updates: Real estate managers may have to amend playbooks to incorporate revised workflow, as well as new leasing policies, standard lease terms, covenants, and other key clauses.
Key Financial Ratios: Finance/Accounting may coordinate with real estate managers to evaluate the impact the new lease standards will have on key financial ratios and debt covenants to ensure that minimum threshold requirements are maintained.
Transition Budget: Budgeting for transition resources and software is critical to avoid any unforeseen expenses.
Peter Brohoski is the Senior Managing Director of the Global Occupier Services group at Cushman & Wakefield.