How to Begin Planning for the New Lease Standard

January 27, 2020 | Article

By Matthew Neir

The impact of the new lease standard is far reaching and may substantially change the way items are recorded. Here are some answers to common questions regarding how your organization should get started on implementation.

What is the New Lease Accounting Standard?
The FASB’s new lease standard introduces major changes in financial reporting of lease arrangements. This new accounting standard directly impacts lessees, as significantly more leasing arrangements will need to be reported on the balance sheets of lessees.

Here’s what you need to know about the FASB’s final standard on lease accounting.

When is the New Lease Standard Effective?
The effective date of Topic 842, the new lease standard, was delayed for nonpublic companies to periods beginning after December 15, 2020. With significant balance sheet effects for most companies, there is no time like the present to start preparing for implementation.

How Can I Prepare for Implementation?
Here are some recommendations to ensure your organization is ready to handle this new standard.

1. Prepare Complete Listing of Leases
The starting place for implementation is ensuring you have a complete listing of all known lease contracts for property, plant and equipment. However, since leases can be in contracts that you would not expect to have leases, such as service contracts for storage space, long-term supply agreements, delivery services, and IT software contracts, you will also need to broaden your review to more than your organization’s current lease expense accounts.

The best place to start is to review all expense accounts and look for recurring payments, because these often have the potential to have contracts that contain a lease. Once you have a list of recurring payments, review the contracts for these payments to identify leases. If the contract meets the elements of a lease—a contract for an identified fixed asset that your organization controls the use over the contract period—your organization has a lease that should be added to your listing.

2. Determine Software Needs
Once you have identified and compiled all your organization’s leases, you will need to decide how to track leases going forward. There are numerous ways to track leases, including using a spreadsheet, using an additional module to your current software, or using new software separate from your current general ledger. Here are some factors to consider:

  • Amount of leasing activity – Are there only a few leases that are consistent each year or are there several new lease contracts every year?
  • General ledger software capabilities – Does your company’s current software have a module to calculate the journal entries for the leasing standard?
  • Process for identifying a new lease – Are signed contracts routed to a central location or stored across several locations?
  • Location of the leased assets – Are they all in one location or disbursed across the organization or world?
  • Maintenance of lease contracts – Are contracts stored in a central location or at locations throughout your organization?
  • Lease renewals – How are managers notified when renewals are coming?

Software providers have developed solutions to these questions that could make the process more efficient for your organization. However, the most robust solution is not always the best solution, and there are always software and implementation costs to consider. Careful consideration of current process and future needs are key to finding the correct solution.

3. Define Implementation Strategies
When implementing the new lease standard, there are certain elections to consider. Depending on your organization’s specific situation, these elections could save you time in the implementation process.

First, consider what periods to apply the new standard to. There are two options: All comparative periods presented or only for the period of adoption. The implementation of the standard will be very different depending on which of these two options you choose. Second, consider some of these other elections in your organization’s implementation:

  • Package of practical expedients for not reassessing contracts for leases, lease classification and initial direct costs.
  • Recording leases with terms of 12 months or less in expense without capitalization.
  • Including non-lease payments with lease payments when recording a lease asset and a liability.
  • Determining the discount by using an incremental borrowing rate or risk-free rate for nonpublic companies.

4. Educate Key Stakeholders on the Changes
The impact of this standard depends on the significance of the leasing activities; however, the financial statements of any entity with leasing activity will be impacted, and entities with significant operating leases will be significantly impacted. When the lease liabilities are added to your balance sheet, it could have an impact on financial leverage ratios that lenders will consider when making lending decisions.

Educating your organization’s board of directors and users of your organization’s financial statements (banks, bonding agencies, grant agencies, etc.) prior to issuing the first financial statements after implementation will alleviate surprises for these stakeholders.

Pay attention to industry specific implications
The new lease standard impacts a wide variety of industries. Here are a few industry specific impacts to consider:

For healthcare entities, there is a unique consideration due to some of the types of lease agreements that have been developed. A primary example is lab equipment that the healthcare entity received for free after purchasing a certain level of reagent or other supplies within a certain timeframe. This type of arrangement is what is termed an embedded lease, and the agreement will need to be carefully reviewed to determine the lease component—likely, a right-of use-asset and lease liability will be recorded. There are other examples of this type of arrangement with radiology, IV pumps, etc.

Community Banks
The first step is to educate the bank’s management team with the general requirements of the standard. After spending some time going through the new standard, the bank should prepare an inventory of all significant contracts it has with third parties. The reason for the inventory is to identify potential leases that could be embedded in standard third-party agreements. The definition of a lease will change with this new standard, which notes property, plant or equipment can be the subject of a lease. Expect this inventory to take some time, as most agreements are not all housed in one central place at a bank.

Once you have a complete inventory of all leases, the bank will need to consider updating the process and controls surrounding entering into, modifying and terminating a lease. The process and controls should be established to ensure accurate and consistent records are kept reflecting the proper accounting associated with the new lease standard. There will also be additional financial statement disclosures under the new lease standard, and controls need to be implemented to support management’s significant judgments and estimates.

The final step will be evaluating the impact of the new lease standard on the community bank. The Federal Financial Institutions Examination Council posted their Supplemental Instructions for the Second 2018 Call, number 284. In these instructions, the agencies noted that a right of use asset must be risk weighted 100% under Section 32(I)(5) of the agencies’ regulatory capital rules, and the asset will be included in the institution’s total assets for leverage capital purposes. Based on the accounting for the new lease standard, it is possible to have a cumulative effect adjustment to retained earnings on the date of adoption. In addition to these regulatory capital and equity impacts, the bank could have covenants on borrowings that might be affected by these changes.

The new lease standard will also have a significant impact on the potential sale of a business.

The Importance of Beginning Implementation Early
There are a lot of considerations and activities that need to occur when implementing the new lease standard. Contracts need to be complied and assessed for leases, decisions about technology need to be made, and implementation strategies need to be considered.

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