After 10 long years of deliberations, the FASB and IASB have now finalized the new lease accounting guidelines. Any lease that you sign today will be capitalized and put on the balance sheet in the near future. In addition, most of your existing leases will also be capitalized and put on the balance sheet in the near future. The time to optimize your lease portfolio is right now! There are three key steps to make this happen:
STEP 1. EDUCATION
You must learn everything you can about capitalizing leases. The goal is to capitalize the least amount of rent possible, while at the same time making good business decisions. There are ways to negotiate and structure lease contracts that will minimize the impact on your balance sheet. You must understand…
- The good and bad clauses in lease contracts.
- How to calculate the capitalization term.
- What expenses are subject to capitalization?
- How do you calculate the PV of the lease obligation?
- What discount rate do you use?
- What deductions can you take to reduce the rent to be capitalized?
- What landlord allowances are you getting?
- What initial direct costs are you incurring?
- Are there any impairment credits?
You cannot take one step forward in the process without knowing the answers to these questions.
STEP 2. CREATE A PLAYBOOK
The more you learn about capitalizing leases, the more you will realize how vague the accounting guidance actually is, and how many questions you still have. When it comes to accounting for real estate and equipment leases, the only thing that matters is that your decisions are agreed upon and approved by your auditor. Therefore, before you start creating capitalization schedules for all of your leases, you will want to sit down with your auditor and get answers to any of your questions. Wherever the guidance is vague, you will need your auditor to give you definitive thresholds and tests to perform so you will know how to capitalize each lease.
Our recommendation is to create a “Real Estate Playbook”, and a similar playbook for your equipment leases. The goal of your playbook is to:
Optimize the lease portfolio to minimize the impact on the balance sheet.
It is critical that real estate, accounting, finance, treasury and all related departments come together to develop this playbook. As your company does more lease transactions and creates more capitalization schedules, you will have more and more questions. You can continue to ask questions of your auditors and add to the playbook. Your entire team should have access to this playbook and get updates when they are available.
STEP 3. CAPITALIZING YOUR LEASES
Now that you are educated and have developed a lease playbook, please don’t jump in and create capitalization schedules for your 50, 500 or 5,000 leases! We highly recommend you do a sampling of 5-10 leases. Setup capitalization schedules for the sample group and demonstrate the rationale to your auditors. Once they approve, you are ready to capitalize the entire portfolio of leases.
It is important to note that it would be extremely difficult to setup your own tool or system for generating capitalization schedules. We recommend that you review off-the-shelf Lease Administration and Lease Accounting software from an established provider that has thoroughly researched and developed functionality for the new guidelines. Make sure that the provider has complete lease capitalization functionality ready now, not something they are “working on”.
Public Companies – First reporting period starts January 2019, however public companies are mandated by the SEC to provide:
– 3 years of P & L (2019, 2018, 2017)
– 2 years of balance sheet (2019, 2018)
Private Companies – First reporting period starts January 2020. Private companies are not mandated by the SEC to provide any comparables, however any company requesting financials will most likely be looking for at least 2 years of comparables (2019, 2018).
It is a lot of work to prepare your company for the new lease accounting guidelines. It’s going to take education, time and resources to become fully compatible. The time to get started is now!
If you are a ProCalc or ProLease client, please contact us today to schedule your lease capitalization training. We look forward to hearing from you.