Adoption of lease accounting standards such as IFRS 16 is less than a year away, with regulations effective as of January 2019. Treasurers should be aware and involved with their organisation’s lease accounting project planning. If treasury doesn’t start now, it will be a serious problem as lease accounting experts are finding that uncovering the full magnitude of lease contracts takes at least 12 months to complete.
Why is lease accounting so difficult?
There are three components to lease accounting that are especially problematic for treasurers and CFOs:
- Visibility into leases – leasing is not typically a treasury responsibility, meaning that treasury may only have visibility into financial leases and have no understanding of where operating leases are held and by whom.
- Ownership of leases – most organisations have thousands of operating leases, including contracts for services such as IT outsourcing, computers, and mobile phones. All of these may potentially need to be calculated according to the new rules and now stated on the balance sheet.
- Lack of technology – there have been very few software platforms focused on lease accounting, meaning that CFOs have lacked the automation, controls, and audit trails to perform calculations and offer the centralisation and auditability required to achieve full compliance.
What do treasurers need to manage?
To achieve regulatory compliance, corporates must:
- Centralise tracking of all corporate operating leases, including those technically owned by operating units.
- Calculate lease liability and right-of-use asset value for each lease – and generate journal entries to balance sheet accounts.
- Separately manage leasing and other costs such as maintenance costs, stipulated losses, and any embedded derivatives such as purchase options. Each must be accounted for uniquely.
- Manage life-cycle features of leases, such as early termination, extensions, returns, renewals, and purchases.
What happens if lease accounting is done poorly or not at all?
If lease accounting regulations are not met in time, corporates will be penalised – just as they would be with any other missed financial reporting standard.
Should lease accounting be done poorly, the consequences are potentially more significant as restatement of financial reporting is possible. Further, if calculations are not optimised (e.g. using an implied leasing rate when cost of capital would have reduced liability value) then liabilities arising from leases may be higher than necessary on the balance sheet, which could affect both cost and availability of borrowing as well as potentially affecting key ratios used to calculate debt covenants.
What help is available for corporates?
Lease accounting solutions are starting to become available which manage the entire lease lifecycle, from initial classification through to valuation of leases and journal entry automation. Most solutions are standalone in the cloud as a separate implementation and vendor relationship; some are even part of your organisation’s treasury management system – allowing all financial instruments to be managed in the same platform, with the same vendor, and a consistent set of operational controls and security.
What is the best tip that you can provide to a corporate trying to understand their lease accounting responsibilities?
Start now! Establish who will own the centralisation of leases within the organisation and arm them with the tools and resources required to consolidate lease data, create an auditable workflow, and automate the calculations to not only meet initial requirements but also achieve ongoing compliance.