When ASC 842 and IFRS 16 were first announced, there was quite a bit of uncertainty about how the accounting would work for variable rent leases. Large public companies found themselves in the role of early adopters, and had to work out many complex accounting calculations and processes that had never been done before.
FASB and IASB have since provided revised guidance, and accounting advisors and technology providers (like Visual Lease) have learned valuable lessons from the experience of helping public companies move toward compliance in 2018.
If you are part of the next wave of organizations ramping up your lease accounting compliance efforts for the 2019 deadline, you’re in luck. You can benefit from the best practices developed over the past year, and avoid time-consuming mistakes and delays.
Why are variable rent leases so complex from an accounting standpoint?
In the past, the difficulty with variable rent leases was only about calculating the correct payment, whether that was based on on a variable interest rate, CPI increase, a percentage of sales, or some other variable factor.
Under ASC 842 and IFRS 16, variable leases require much more complicated accounting. You’ll need to understand how to break out all the components of variable rent leases, including non-lease components, so you’ll be able to properly represent them on your balance sheet. Also, you need to consider how the accounting treatment will change over time.
Here’s just one example to illustrate some of the issues that will arise with variable rent leases:
Let’s say you have a lease that starts at $10,000 per month, with straightforward CPI increases over time. That base rent of $10,000 goes into the calculation of your ROU asset and liability, and the CPI increases are treated separately as variable payments.
That process continues the same way (although the amounts of CPI increases may change each year) until something happens that requires a remeasurement of the lease, such as exercising an option. Upon remeasurement, all those CPI payments that were variable before now get treated as fixed payments that go into the calculations for ROU assets. Only the future CPI increases (after the remeasurement) qualify for the variable payment treatment.
That’s just for leases with simple CPI increases. What happens if your increase has a floor? Let’s say each increase can’t be less than 2 percent. In that case, the 2 percent becomes part of the fixed payment, and only increases above 2 percent are treated as a variable payment. To complicate matters further, if you also report under IASB or other non-US GAAP standards, CPI increases are handled differently. Your accounting standard must be capable of handling multiple methods simultaneously.
Needless to say, there’s a great deal to learn. When it comes to handling all the complicated scenarios for variable rent leases, you will need guidance from your accounting advisors. Here’s what is critical to know now as you begin preparing for compliance with the new lease standards:
- What variable lease data you need to track in your lease accounting system
- How you must break it out and track it so that you’ll be able to create all these complex calculations over the life of your leases
Best practices for recording and tracking variable rent lease data
1. Identify all the variables in your lease payments
It’s not enough to capture the fact that a lease obligation has a variable component. Different variable payment structures qualify for different accounting treatments. And to further complicate things, under the US standard (ASC 842) variable leases may be treated one way, whereas under the international standard (IFRS 16) variable leases may be treated differently. If you must comply with both, you may need to apply two different accounting treatments to the same lease. That’s why it’s so important to understand and capture every parameter that affects how lease payments change over time.
You’ll need the advice of your accounting partners to decide how you’ll treat different variable payment scenarios as well as what practical expedients you plan to take. Then you can work out what data you’ll need to create the calculations.
2. Isolate every variable in your lease management and accounting system
Create separate line items for every variable; don’t make the mistake of combining them with the overall obligation that’s being increased over time. If everything is lumped together, when a remeasurement occurs you’ll be forced to go back and spend a lot of time making manual accounting adjustments.
3. Creating the data right structure
It’s essential to create the right relationship between your fixed rent components and your variable payment components in your lease system.
On one hand, you need to connect them so that you can combine them for payment purposes. But you must also be able to treat them separately as needed for accounting purposes that change over time.
When a remeasurement event occurs, you’ll be in the best position to make a smooth and easy transition to a different accounting treatment.
Visual Lease accommodates complex lease structures and makes your workflow simple
It’s no secret that accounting for variable rent leases (or any leases that have a variable payment component) is complicated. That was true even before the new lease accounting standards, but under ASC 842 and IFRS 16 the complexity has increased exponentially. Plus, with leases more visible on the balance sheet and making a bigger impact on your financial reporting, the stakes are higher and you need to be sure you get it right.
That’s why Visual Lease has taken what we’ve learned working with the early adopters and built best practices into our tools that adapt to the complexities of variable rent leases. With our smart and flexible data architecture and the ability to change accounting treatments automatically, you not only get to compliance fast, but you do it right so you avoid re-work later. Your Day 2 workflow is simple and efficient
Ready to see how it works? Request a demo now.