Over the past few years, Visual Lease has helped hundreds of public companies achieve compliance with lease accounting standards. For many organizations, real estate lease accounting turned out to be much more complex and time-consuming than they anticipated.
Part of the problem a few years ago was that adopting IFRS 16 and FASB ASC 842 for real estate leases and other leased assets was a new challenge; every company was working through the process for the first time and had little idea what to expect.
1. Overlooking the cost-saving potential of real estate lease accounting software
For most companies, real estate leases represent the bulk of leased assets (not necessarily in number, but in terms of financial value). That’s why it’s smart to think bigger when setting your goals for real estate lease accounting. This exercise can bring more benefits than merely achieving compliance with accounting standards. The data you collect for real estate lease accounting calculations, together with your lease accounting software, is a powerful business planning tool that can help you take control of property costs.
Thinking about these larger goals as you begin to plan for your compliance project will impact what data you collect, the team you put together, and the tools you select.
2. Failing to Recognize Embedded Leases
One of the most commonly overlooked aspects of real estate lease accounting is identifying embedded leases. Embedded leases are hidden within broader service agreements—such as those for IT equipment, utilities, or maintenance contracts—and meet the definition of a lease under ASC 842 or IFRS 16. Failing to account for these can lead to incomplete financial reporting, compliance issues, and even penalties.
Embedded leases often require careful examination of contracts, as they aren’t always explicitly labeled as leases. For instance, a contract for office cleaning services may include the use of specialized equipment controlled by the lessee, qualifying as an embedded lease.
To avoid this mistake, conduct a review of service agreements tied to your real estate portfolio. Train your team to identify embedded leases, and use lease accounting software with analysis tools to flag potential issues. The extra step ensures that all lease obligations are captured accurately and avoids surprises during audits.
3. Underestimating the task of gathering real estate lease data
Here’s a promise: it will take more time and resources than you expect to collect all the lease data you need for lease accounting calculations. That especially true for real estate lease accounting, due to the complex nature of those leases and the fact that you can’t get all the data you need from the lease contracts. Our advice: don’t delay!
Organizations make the mistake of hearing an estimated implementation timeline from a software vendor (ours is 90 days) and assume they have plenty of time to get started. However, that 90 day timeline starts when your team is ready with lease data abstracted, assembled, verified, and ready for importing into the system.
Not having your data ready for software implementation (i.e. incomplete data and incorrect data) can result in significant delays.
4. Not Planning for Lease Modifications and Terminations
Real estate leases are rarely static, often involving modifications such as renewals, early terminations, or changes to key terms like rent or square footage. These modifications must be tracked and properly accounted for to ensure accurate financial reporting. Many organizations make the mistake of not having a process in place to manage these changes, leading to compliance risks and financial discrepancies.
For example, if a company negotiates a lease extension but fails to update the accounting records, it could result in misaligned financial statements. Lease terminations can also complicate matters if the exit costs or obligations are not clearly tracked and reported.
Implement workflows and processes to track lease modifications and terminations proactively. Use technology to automate reminders for critical dates and set up alerts for when negotiations result in new terms. A good lease accounting system can ensure that these updates are reflected accurately in financial statements and compliance reports.
5. Ignoring Tax Implications of Lease Accounting
Ignoring tax implications can lead to unexpected tax liabilities and missed opportunities for deductions. For example, deferred rent liabilities or large upfront payments for leasehold improvements must be carefully tracked and reported to avoid discrepancies during tax filings.
Lease accounting decisions, such as whether to classify a lease as operating or finance, can also have tax impacts. For instance, finance leases may affect depreciation and interest expense deductions, altering a company’s tax obligations. Without clear alignment between the accounting and tax departments, businesses may face compliance risks or miss out on tax-saving opportunities.
To avoid this, collaborate with tax advisors early in the process to ensure tax strategies align with accounting. Use lease accounting software that integrates with tax planning tools and provides detailed reporting on tax-related items, such as deferred rent, leasehold improvements, and capitalized costs.
6. Misclassifying Real Estate Leases
Accurate classification of real estate leases as either operating or finance leases is crucial for compliance and financial reporting. Misclassification can lead to errors in balance sheet presentation, incorrect profit and loss impacts, and potential audit findings. Real estate leases have complex terms and conditions and are prone to misclassification when companies rely on manual processes or outdated systems.
For instance, failing to account for clauses like renewal options or purchase rights can result in an incorrect classification. Failing to apply the lease classification tests outlined in ASC 842 or IFRS 16 can lead to financial misstatements. Both of these can be costly and time-consuming to correct, especially during audits.
Avoid this by establishing a clear and detailed process for lease classification that incorporates all relevant lease terms, including renewal and termination options. Ensure cross-department collaboration between finance, legal, and real estate teams to collect all necessary details. Lease accounting software with automated classification tools can simplify this process and ensure compliance by reducing the risk of manual error.
7. Neglecting Cross-Departmental Collaboration
Effective lease accounting requires input from multiple departments, including finance, legal, real estate, and facilities management. However, many organizations fail to establish clear communication channels and workflows, which usually leads to incomplete data and lease records. This often results in reporting errors, compliance risks, and missed cost-savings.
For example, the finance team may focus solely on payment schedules, while the legal team tracks lease terms, and facilities management oversees space utilization. Without a centralized approach, important data points may be overlooked.
A way to combat this is by leveraging a lease management software that centralizes all lease data into one platform. That way, all departments have a single source of data compiled into one platform that allows for easy viewing and analyzing of all lease data.
Visual Lease has decades of experience with real estate leases, so our platform is designed not only to help you achieve lease accounting compliance, but also to help you manage leases and optimize your real estate expenses.
Want to see how Visual Lease’s real estate accounting software works? Schedule a demo now.
