Lease modification accounting is a subject that isn’t getting as much attention as it should… yet. That’s going to change the closer we get closer to the deadline for IFRS and FASB compliance. The smartest accounting leaders are planning for it now.
Why worry about lease modification accounting now?
As the deadline quickly approaches for adopting the new lease accounting standards, your accounting teams are scrambling to collect all your lease data and get ready for initial compliance. Simply amassing all that information, and calculating your obligations and right-of-use assets as they currently stand, is a huge burden on the organization. It’s easy to make the mistake of overlooking preparations for Day 2, or what you’ll need to do to maintain your compliance after the effective date of the new standards.
Lease modification accounting is the biggest Day 2 challenge, especially for large organizations with hundreds or even thousands of leases. Accounting for lease obligations and assets is no longer a set-it-and-forget-it exercise. Every time a lease changes, and even when your assumptions about leases change, you’ll need to revise your lease liability accounting as well as entries for right-of-use asset.
Why worry about lease modification accounting now? Understanding it now will impact the processes and procedures you’ll need to put into place before you adopt the IFRS and FASB changes. And, if you’re smart, it will impact your choice of lease accounting technology.
Lease modification accounting is much more complex under the new standards
If you think figuring out how to get all your leases onto the balance sheet is complicated, just wait until you have to keep track of all the changes. And keep your journal entries and disclosures up-to-date and accurate.
In the past, leases that were included on the balance sheet needed to be updated only when the terms of the lease were actually changed. Under the new lease accounting standards, FASB ASC 842 and IFRS 16, you’ll also need to do lease modification accounting when assumptions change… those you used to calculate your initial classification and measurement of lease obligations.
What does that mean? You make certain assumptions when you classify a lease as an operating lease or a finance lease.
When calculating your lease obligations and right-of-use-assets, you also make assumptions about whether or not you’re “reasonably certain” to exercise options. Both of these impact your lease accounting calculations, and when those assumptions change, your balance sheet will also need to change.
What does lease modification accounting entail? When you have lease modifications caused by lease term revisions and changes to assumptions, you’ll sometimes need to re-assess your lease classification. You’ll also need to remeasure your lease, or re-calculate your lease obligations and right-of-use assets based on the change. Also, it’s likely you’ll need to document the reasons for the accounting changes in disclosure reports.
Let’s look at some examples of when you’ll need to do lease modification accounting.
When do you need to re-assess lease classification and re-measure a lease?
According to the new lease accounting standards, there are two types of “triggering events” that could cause you to have to re-classify and/or remeasure your lease:
- Contract-based events, such as an upcoming deadline for exercising an option to purchase the asset or renew the lease.
- Other events under your control as the lessee. This is where those “reasonable certainty” decisions come into play. In many cases they will be decisions that you expected to go one way, but you revise the decision based on market conditions, business conditions, or something else.
Here are just a few common examples of events that cause lease changes and the need for lease modification accounting:
- Exercising an option to purchase a leased asset.
- Exercising an option to renew a lease.
- Terminating a lease early.
- Adding additional space or reducing space associated with a property lease (this might be done as a lease modification or as a new lease).
- Re-negotiating lease terms with the lessor to change payment amounts, due dates or other terms.
- Changing assumptions, such as whether you expect to exercise an option to renew a lease or exercise an option to purchase the underlying asset.
How to prepare now for lease modification accounting changes
Especially for organizations with a large number of leases, keeping up with all these changes will be a big challenge. There are two components to this challenge:
- Keeping accounting in the loop about all lease modifications and revised assumptions about leases.
- Executing the lease modification accounting calculations.
Here’s what you can do now to make sure your lease accounting stays accurate and in compliance after you implement the new standards.
1. Put policies and procedures into place for capturing lease changes and potential lease changes.
Chances are, your organization has many different teams involved in making lease decisions and maintaining leases. Your corporate real estate team is managing your valuable property leases: deciding whether to renew leases, take on new space, or make improvements to existing space that you expect to keep for a while. Also, you have procurement and IT teams managing equipment leases that are essential for your business: computer equipment, vehicles, construction equipment, or other specialty equipment.
Chances are, none of those teams are in the habit of communicating information to accounting about lease changes. That’s going to have to change very soon. Now is the time to put processes and procedures into place to ensure your accounting teams get all the data they need to stay on top of lease modification accounting.
TIP: Those processes are going to be much easier to implement and manage if ALL your lease data is in one place.
2. Choose lease accounting software that makes it easy to do lease modifications.
There are a lot of different ways that leases can change, and the lease modification accounting treatments can be very different depending on the situation.
Your accounting teams are going to be snowed under if they need to manually calculate the changes every time a lease changes (or your assumptions change).
You’ll save a lot of time and frustration with the right lease accounting technology. While many products make it possible for you to make lease changes, the best make it easy by offering a lease modification accounting wizard that asks you questions and automatically adjusts your accounting, creating the required journal entries and disclosure reports.
Want to see how that works? Get a personalized demo of Visual Lease.