Adoption of lease accounting standards such as IFRS16 is less than a year away, with regulations effective as of January 2019. Yet, with over two years to prepare already, most corporates report not being ready for the transition. In fact, most treasurers are either unaware of or not involved with their organization’s lease accounting project planning. This is 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 to financial leases and have no understanding of who and where operating leases are held
- Ownership of leases – most organizations have thousands of operating leases, including contracts for services such as IT outsourcing, computers, and mobile phones that can potentially be part of the operating leases that need to be calculated and now stated on the balance sheet
- Lack of technology – there have been very few software platforms focused on lease accounting, meaning that CFOs lacked the automation, controls, and audit trails to perform calculations and offer the centralization and auditability that are required to achieve full compliance
What do treasurers need to manage compliance?
To achieve regulatory compliance, corporates must:
- Centralize 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 such as early termination, extensions, returns, renewals, and purchases
Related reading: Hackett: CFOs Should Consider Treasury Tech to Support Growth Objectives
Fact sheet: Kyriba Lease Accounting
Case study: Leveraging Technology to become a “Smart Treasury”
What happens if lease accounting is done poorly or not at all?
If lease accounting regulations are not met in time, corporates would be penalized just as they would 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 optimized (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 stand-alone in the cloud as a separate implementation and vendor relationship; some are even part of your organization’s treasury management system which allows all financial instruments to be managed in the same platform, with the same vendor, and have 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 centralization of leases within the organization 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.