Big changes are on the way in the lease accounting world
The FASB and IASB (“the Boards”) are expected to finalize their respective new lease accounting standards towards the end of 2015. The Boards will set an effective date before issuing the new standards. The new standards will radically transform lease accounting:
- Balance sheets, income statements, cash flows will change for lessors and lessees
- Essentially all leased assets currently classified as operating leases will be brought on balance sheet
- Subsequent evaluation and measurement will require expanded capabilities in technology and other finance function processes
So what do finance teams need to do in preparation for the changes?
1. Examine Inventory of Leasing Arrangements
Evaluate contractual arrangements to determine lease qualification and lease type. Key factors include commencement date, lease term, lease payments (including fixed, variable, amounts payable under residual guarantees, termination penalties and purchase option payments). Judgment is required in the assessment as to whether the occurrence of certain key factors are considered “reasonably certain”. This will require a careful re-examination of all lease arrangements.
2. Assess the Financial Statement Implications
Balance sheet, income statement, cash flows – expect changes. Lessees would effectively be required to capitalize all leases beyond one year on their balance sheet. Higher liabilities arising from contractual obligations that were previously off balance sheet would likely result. The income statement may see higher interest expense in the early years of a lease. The arrangements for lessors will be somewhat similar to today’s sales-type lease and operating lease approach under the current standards. The financial statement effect on key metrics, including management reporting, investor reporting, and debt covenants will need to be assessed.
3. Determine if Adequate Systems are in Place
The calculation of fair values, carrying values, residual values and lease income and expense, as well as the associated judgments and estimates may all change requiring new templates, processes and controls. This may prove cumbersome, particularly for firms with a large volume of leased assets. Current ERP systems may not meet the requirements of the new standards. A new or upgraded fixed assets system in particular may be a requirement. If current systems are deemed appropriate in a broad sense, cloud based solutions may provide support for the ERP system in terms of add-ons and/or revised reporting tools.
4. Assess the Commercial and Other Impacts
Lessees may begin to adjust their lease vs. buy decisions. Lessors need to underline the merits of the leasing model such as reduced capital outlays, lower residual risk and portfolio management flexibility. The changes may result in revised tax strategies. An understanding of the impact on existing tax positions, deferred taxes and tracking accounting to tax differences will be important.
5. Plan Accordingly
Changes of this magnitude must be planned out well in advance of implementation. Whether or not new systems will be required, a detailed plan is still essential in order to minimize disruption to everyday workloads and to facilitate a seamless period-end close. A cross-functional project team may be required to gather the information needed. Consideration of workloads, augmenting current staffing levels and staff training will all be important. A detailed roadmap to include a design stage, implementation stage and post-completion stage where appropriate should be undertaken.