Many business entities use leases to finance their real estate and equipment needs. Many provide financial statements to stakeholders prepared using accounting principles generally accepted in the United States.
After multiple deferrals, a new generally accepted accounting standard that guides the treatment of leases becomes effective for nonpublic business entities with fiscal years beginning after Dec. 15, 2021.
Previously, the commitment for leases that met the definition of an operating lease were not recorded in an entity’s balance sheet but were disclosed as a commitment in the footnotes to the financial statement.
The new standard generally provides that long-term leases will be reflected as a “right to use” asset with a lease liability reflected as the present value of the lease payments to be made throughout the lease term.
It is easy to see that this could represent a significant change to the balance sheet of a business that use leases in its operations. Stakeholders could benefit from education about the impact of this change on the financial statements of the entity, and to the extent an entity has debt with covenants, entities should assess potential impacts on covenant compliance.
As with many new accounting standards, public business entities have required new leasing standards, and much has been learned that can assist nonpublic business entities as they implement the new guidance.
• Frequently, entities find there are more contracts that meet the definition of a lease than they originally thought.
• Determining the inventory of contracts can be challenging if there is no centralized contract management system.
• Calculations can be complex and require more judgment.
• Estimates are not locked in at the inception of the lease. Instead, assumptions are periodically re-evaluated over the lease term.
• Organizations frequently underestimate the time necessary to implement the new standard.
Most entities have historically used excel models to determine the accounting for lease agreements and gather necessary information for lease disclosure requirements.
With the complexities above, I typically recommend clients with more than five to 10 leases purchase lease accounting software. Several software solutions available in the marketplace are affordable, scalable and effectively tailored to the specific complexities of the new lease accounting standards.
Lease software increases automation in the initial implementation, accumulation of data for monthly journal entries, and the accumulation of data for disclosure requirements.
Organizations with significant or complex lease portfolios and who may not have sufficient internal resources may find it beneficial to outsource the initial adoption and, in some situations, the ongoing accounting for leases.
If an entity has not yet started their implementation, the time to act is now. It takes most entities two to three months to implement. Most entities will want to include a selection and implementation of lease accounting software or outsourcing solution within its adoption timeline.
As the calendar year progresses, software companies and other service providers are likely to be capacity constrained, which could increase costs for entities to implement. Entities that desire additional insights or implementation assistance should speak to their accounting advisory provider.