Adopting FASB 842 and IFRS 16 requires you to revamp your lease accounting practices. In order to transition properly and maintain compliance going forward, you’ll need to collect comprehensive data for each of your company’s leases.
Here’s an overview of what data you should be collecting and how to do it. In order to comply with Topic 842, you need three pieces of data: The lease start date (possession date), the lease end date, the frequency and amounts of payments, and finally your borrowing rate as of the lease start date.
Start with the right team
To get an accurate record of all of your leases, you need to pull together a cross-functional team. Your team should include supply chain, purchasing, or procurement groups, as well as legal, real estate, and IT departments. Any departments that may be aware of potential leases should be a part of your cross-functional group.
Look beyond the obvious
Now that you’ve got the right parties involved, you want to make sure your accounting is complete. To do that, it’s important to look beyond the usual suspects, like real estate and vehicle leases.
Service agreements often contain embedded leases that can go unnoticed. Because you’re contracting a vendor for a service – say transportation or data center operation – you may not realize that you’re actually leasing equipment or space in the process.
Here’s one example that can easily fly under the radar: ABC Co. operates a remote manufacturing plant. To meet its demand for electricity, ABC Co. may enter into an agreement with the local power company to supply its power from a particular plant.
In this case, the power company is allocating specific assets to be used exclusively for ABC Co.’s plant. That’s a potential embedded lease.
Missing embedded leases will lead to material misstatements, yet many companies aren’t being diligent enough about evaluating them.
Effectively capturing embedded leases
Every service contract should be reviewed for embedded leases. Because many companies don’t have a centralized contract management system, you’ll need to be resourceful in your approach.
This is why your cross-functional team is so critical. A good place to start is by talking to accounts payable and looking at recurring payments. From there, you can look at the service contracts tied to those payments and drill down to see if they contain leases.
You can also reach out to your vendors for this information. The initial review will be time-consuming, but it’s worth it to set yourself up for compliance in 2019 and beyond.
A checklist of what to collect on each lease
Once you’ve gathered all of your contracts, here’s the data you need to collect on each one:
- Timeframe: This is self-explanatory. You need to have start and end dates for each lease.
- Use of an asset: To determine if you have an embedded lease, you must first identify the asset that you may have exclusive control over, keeping in mind that the identification may be explicit or implicit.
- Documentation of allocation methods: For embedded leases, you need to use systemic, rational methods to allocate the “consideration” (or fixed payments) by determining the fair value of the lease and non-lease components to which you have exclusive rights. The new standards require that you document how you determine that value.
- Historical currency rates: You may have contracts that are denominated in a currency that is different from your functional currency. In this scenario, you need to capture the historical conversion rate, which is the rate that was in place as of the start of the contract. This is important because the ROU asset for leases under Topic 842 and IFRS 16 is a non-monetary asset, which requires “remeasurement” as opposed to “translation” from transactional currency to local currency.
Don’t put the cart before the horse
The next step after gathering all of the data you need is choosing your software. Many legacy lease accounting software programs primarily handle real estate. Those programs aren’t useful for the broad range of leases that you may have.
You wouldn’t invest in a house without considering your needs first. The same goes for lease accounting software.
In our step-by-step transition guide, choosing software is the 14th step. It’s only after you’ve developed a thorough understanding of what kinds of leases you have that you can choose the right software to manage your needs.
Ensuring compliance as you move forward
Once the transition to FASB 842 and IFRS 16 is complete, accounting should be involved in your contract workflow. Just as contracts make their way through procurement and legal, the accounting department should have an opportunity to extract the data it needs from each contract in order to determine if an embedded lease exists. This will enable efficient, compliant record-keeping going forward.
LeaseQuery helps you take the guesswork out of transitioning to the new lease accounting standards with our Lease Accounting Transition Guide. This step-by-step guide will help you navigate through the new standards and avoid pitfalls along the way.