As two of the accounting world's major governing bodies—the FASB and the IASB—converge, they're scrutinizing how businesses track lease expenses. Under existing accounting standards, a majority of leases are not reported on a lessee's balance sheet. The amounts involved can be substantial, as many firms lease much of their equipment. Affected companies need to have a strategy in place.
Lease accounting criticism has centered on not recognizing leases as operating expenses that occur, because this leaves large amounts of income remaining in the value of those leases, says Dean Sonderegger, executive director of product management for Bloomberg BNA software. "The pending rule would change how firms calculate their value." The proposed new standard, which was released for comments as an exposure draft last year, would require lessees to include all leases, including leases of equipment and other assets, generally classified as operating leases.
In 2015, the new standards are expected to be finalized and will be reflected in the way companies treat leases and track their performance. "Trillions in historically off-balance-sheet leases will have to be brought onto companies' books", Sonderegger says. The calculations used for lease liabilities and amortization will change: For most real estate leases, a lessee would report a straight-line lease expense in its income statement; for most other leases, such as equipment or vehicles, a lessee would report amortization of the asset separately from interest on the lease liability.
This is why Sonderegger advises thinking about updating fixed-asset management software to reflect both U.S. GAAP and the IFRS so that the onslaught of new leases can be integrated into existing accounting systems. "It makes reconciliation for the two more and more difficult if you don't", he notes. Either buying a new module or updating your existing software is warranted.
"Companies need to think, 'What is my path forward? What are my options?'" Sonderegger says. "Many firms lease equipment—it's a growing trend, and that's why now is the time to think about whether their software is going to be able to handle the change", he adds. Make sure you've got a solution in place. How? Consider these "Top 5 To-Do's":
- Understand your exposure. What's the monetary value of your leases that need to be added to the balance sheet?
- Contact your accounting software/ERP vendor. What are the vendor's plans to support lease accounting changes?
- Evaluate the impact. Does your accounting software require you to update your software? Is this something that you can easily or reasonably do?
- Consider alternatives. Changes in regulations are an excellent time to take a hard look at alternative software solutions. Would a best-of-breed fixed-assets system serve better than your current system?
- Plan now. Even though the rules won't be finalized until 2015, system changes can require planning. Start the process now to ensure you have budget and resources in place in order to update and change systems and processes to support the new rules.