As a lease accounting solution provider, we talk to finance leaders every day who are facing the 1.1.19 deadline for FASB ASC 842 and/or IFRS 16 compliance. Not surprisingly, we hear similar questions from almost everyone. That’s why we have put together this lease accounting guide to help you with the task you’re probably dreading most: collecting all the data needed to generate lease accounting calculations and reports.
What we’ll cover in this lease accounting guide
These are the questions that come up in every conversation:
– What are the important data points we must collect to produce FASB calculations?
– How do I get that data into my lease accounting software? We addressed this question a couple of weeks ago. Here’s the link in case you missed it: How to Get Data Into Your Lease Accounting Tool.
When people ask the question about data points, they’re hoping we can hand them a complete list of all the fields they need to fill in or a lease accounting example they can follow. Unfortunately, it’s not quite that simple for a few reasons:
1. The data you need to track in your lease accounting software depends on many factors such as the type of leased assets you have, how your leases are structured, your financial reporting needs, and your goals for managing your leased assets.
2. Never depend on any canned list from a service provider. Always consult with your accounting advisor for new lease accounting guidance. You may need help with interpreting lease data, making decisions, and ensuring you’re capturing lease data accurately.
3. To get prepared for FASB, you need much more than a list of data points to capture. You need to understand what to look for in your leases, what to collect from your financials and market information, and what to think about as you collect data.
In this lease accounting guide, instead of a list, we’ll help you understand the process and the types of data you’ll need for basic FASB calculations. We’ll also point out the questions you need to ask along the way to make sure, at the end of the day, you have complete and accurate lease accounting reports that are optimized for your business.
First things first: identify and categorize your leases
When we first begin to work with a client, we recommend starting by identifying everything categorized as a lease.
That in itself can be complex and time-consuming. Not everything you think of as a lease qualifies as a lease for FASB. Also, the reverse is true: some contracts that don’t contain the word “lease” actually do qualify as a lease. We’ve seen some very unique ones that you might not think about, such as box seats at a stadium.
You will need to go over service contracts and other types of agreements to identify embedded leases. Here’s a helpful article that addresses how to do that: Embedded Leases Accounting: Do Your Contracts Contain Leases?
Most organizations don’t have much trouble pulling together real estate leases. After all, you need that to pay bills and handle the day-to-day operation of your facilities. Chances are you have that data in some central location, even if it’s a collection of spreadsheets.
Leases for equipment and other assets tend to be more problematic. You may have many different people and departments leasing smaller assets such as vehicles, computers and office equipment. Very rarely do we find a company that has all that information in a one place. It may take some detective work to find all the lease documents. As a starting point, get scanned copies of every lease in a central location.
Once you have managed to collect all your lease documents, the next step is to organize into any categories you will need for reporting purposes. For example, most organizations will track real estate leases separately from equipment leases. However, you may want to get more granular and separate other assets into specific classes.
At this point, you’re ready to start extracting the required FASB data points. Many organizations start with only the FASB lease accounting essentials for the first pass, because 1.1.19 is coming fast and missing the deadline is not an option anyone wants to think about!
The essential lease data for FASB is all about DATES and DOLLARS. The rest of this lease accounting guide explains what you need to collect and what you must consider as you do so.
Essential data for FASB: DATES
To do FASB lease accounting calculations, you need to collect all the key dates associated with your leases. These include:
When your lease term starts and ends. This is straightforward and can be found on the lease contract or a lease commencement letter.
Lease options that, if exercised, may change when the lease ends. For example, does the lease include an option to terminate prior to the expiration date? Is there an option to extend the lease past the original end date? Do you have an option to purchase the property or asset? Can you exercise the option unilaterally? That means you can just execute the option as stated in the lease and you don’t need consent from the owner/lessor.
DATES: what you need to think about
How will you determine if you’re reasonably certain to exercise lease options?
To do FASB calculations, you must be able to specify if you are reasonably certain to exercise lease options. That’s because the answer to that question determines the lease end date used to calculate your lease liability. Do you have a process in place to regularly review leases and make those decisions?
How will you make sure you don’t miss critical option dates?
To exercise lease options (to renew a lease or terminate early), you must take action by a specified date, which usually means notifying the owner/lessor of your intention to exercise the option. You might not need to track those notification dates to do your lease accounting calculations. However, failing to track these dates in your lease accounting system will come back to bite you.
You’ll want to record lease options so you can do hypothetical calculations that help you make the best decisions about exercising options. In Visual Lease, for example, you can see side-by-side comparisons with different options and schedules to see how they impact your business.
So what can happen if you’re not tracking the option dates? You might forget to notify the owner about a renewal option you intended to exercise. That probably means you’ll lose the favorable lease terms and pay much more for the renewal. Then all the due diligence you’ve done to choose the right financial plan is wasted.
Always make sure you’re not overlooking critical operational dates for the current lease term! And that your software provides alerts for these critical dates.
Essential data for FASB: DOLLARS
The next step is collecting expense information.
Fixed rent. Your FASB calculations need to show the fixed rent obligation for each right-of-use asset. Be careful about extracting “fixed rent” terms from leases. There may be additional expenses you need to include, such as recurring charges for parking or storage.
Rent escalation. How are your leases structured? Examine leases for details about how rent escalates. If the lease language is difficult to understand or has a variable contingencies such as CPI adjusted rents or rent due based on consumption or volume (such as number of parking spaces or a percentage of gross sales), you may need help from your accounting advisors to determine how to do the calculations.
Other charges. Depending on which practical expedient you decide to take, you may need to record real estate CAM (common area maintenance) charges, taxes and insurance.
DOLLARS: what you need to think about
How should you account for extra charges beyond fixed rent?
Ask yourself, what’s the intent of these charges? Are they really adjusted rents? Variable rents? Do they change based on specific circumstances? Talk to your accounting advisor to help you accurately interpret and extract the relevant expenses.
Will you take practical expedients?
As a lessor, you’re entitled to take a practical expedient when reporting on certain expenses, such as CAM charges. You’ll need to define how you intend to account for each asset class. Make sure you’re capturing asset data in a way that can be meaningfully grouped and reported on.
Do you need to validate straightline rent calculations?
Are you comfortable with your current straightline rent schedule (how you’re normalizing rent over the life of the lease)? If that process has been manual, you might not be sure you can count on the accuracy. For FASB liability calculations, you need to be able to extract an accurate deferred rent starting balance as of the day you move to ASC 842. Your software vendor may be able to help. Visual Lease has a tool that calculates the figures you need to validate your straightline rent calculations based on your financials.
These are the basics that get you to FASB ASC 842 compliance and allow you to produce reports that you’re comfortable sharing with auditors.
Next steps: post-compliance lease data
We’ll conclude this lease accounting guide with one final bit of advice: don’t view achieving FASB ASC 842 compliance as the end game. From an operational standpoint, you have much to gain from taking full advantage of all the capabilities of your leasing software.
After you get the FASB essentials well underway, the next step is to collect and migrate operational and performance data for your leased assets. Read these related articles to learn more: