New Rules For Lease Accounting

CFOs are finding the scrutiny of new accounting rules is helping them streamline their lease management and save money, but there are challenges.

Despite being given three full years to prepare for new lease-accounting standards from the International Accounting Standards Board (IASB), even after two years operating under the new rules, many CFOs around the world find they are still feeling the impact and making adjustments to their lease and accounting practices.

US private company CFOs, only now forced to face a similar standard from the Financial Accounting Standards Board (FASB), could learn much from the experience of their international peers.

The IASB standard, IFRS 16, effective as of Jan 1, 2019, requires a lessee to recognize assets and liabilities arising from leases on its balance sheet. “It’s a completely different way of looking at leases,” says Kim Vinkler, finance director for Partnership Countries and former head of Group Accounting and Cost Controlling at ISS, a publicly listed workplace experience and facility management company based in Copenhagen with leases in 50 countries. “In the past, you expensed them. Now you need to capitalize them as an interest-bearing debt.”

The FASB granted private companies a reprieve until fiscal 2021 to align with the parallel US standard, ASC 842, so CFOs in the US are only now confronting the impacts. The new standards demand a much higher level of reporting than in the past, with details on every change to leases throughout the year. “You have to make sure that you have all of your leases registered, that you have them all in the system, you have the terms and conditions correct, and that you’ve got the accounting right,” says Vinkler, “and you have you do this monthly, as opposed to quarterly.”

Aside from the actual accounting, the lease standard caused sweeping changes in how leases are managed and controlled. As Vinkler explains, ISS has more than 23,000 leases spread across 50 countries—and they were basically hidden from corporate view.

“As leases were simply an expense, we originally had a very limited understanding of, first, where they were, and second, how effectively they were being managed,” he says. Lease data was stored in a variety of formats, he adds: “Excel spreadsheets, paper in a folder, or somewhere under the couch … we had no idea.” 

IFRS 16 demanded that the company apply much greater discipline to the lease management processes. “We have definitely learned along the way and are much wiser now,” says Vinkler.

Today, he notes, ISS units in each country take responsibility for compliance based on consistent policies across the company. “Once we addressed the nuances of lease accounting, set some parameters and developed a centralized depository for leases, our local finance departments were able to take over,” he says. “Now, Group only handles difficult or complicated leases, or if we find something in our technology that we don’t expect.”

Ultimately, the exercise of complying with IFRS 16 delivered unexpected, sometimes long-term benefits. Vinkler says ISS identified opportunities to renegotiate some contracts for better terms, and implemented strict companywide policies on entering into new property leases. 

Now that leases are figuring on the balance sheets as assets and liabilities, finance executives are also taking a much greater interest in leasing’s impact on day-to-day operations. “CFOs are rethinking how finance works with real estate,” explains Gavin Maze, head of Account Management & Strategic Bids, Occupier Solutions at MRI Software, a global provider of real estate software applications and hosted solutions.“CFOs are trying to eliminate siloed work, moving away from having a property team on one side of the business and accounting on the other side of the business.”

Where lease management technology can support a more collaborative agenda, he adds, is to allow stakeholders to work on the same platform at the same time. “For example, as the real estate teams are completing rent reviews and negotiations with landlords and tenants, the data is captured at source in real time, and then informs the accounting team for their IFRS 16 reports.”

Meanwhile, most companies have adopted radically new and improved control practices in lease accounting, covering a wide range of potential accounting risks around leases. “These typically will include controls around the identification of a lease contract, classification (either financial or operating), accurately abstracting data, around the ultimate recognition of lease payments and the amortization of the liability, and controls around presentation and disclosure in the financial statements,” explains Aditya Mehta, managing director at Riveron, a US-based business advisory firm.

The complexity seems suited to technological solutions. Lease management software mitigates the need to test and double-check complex calculations, Mehta says, but it’s still necessary to periodically test the technology itself to make sure it’s capturing and reporting what it needs to. Furthermore, “some leases will be too complicated for software and have to be handled manually,” he notes. “But the controls still apply.” 

While devising and implementing lease accounting controls has been a big project related to IFRS compliance, the biggest challenge for companies is keeping up with changes to their leases, Mehta concludes. “The biggest lift post-implementation has been changing business processes to successfully account for leases in the future,” he says. “How do I make sure that my population remains complete? How do I account for modifications, reassessments and terminations of my contracts?  How do I make sure that when a lease is impaired that I’m accounting for it correctly? How do I know if someone in the field has dropped a lease or added a new one?  Those are the operational challenges people are dealing with now, and instituting business processes to capture all of that continues to be the biggest challenge, post-implementation.”

While much of the heavy lifting has been done with respect to lease accounting under IFRS 16 and ASC 842 for US public companies, the verdict is still out on whether the intended benefits have been achieved. It provided some clarity in liability obligations for analysts and rating agencies, says Mehta, but for the individual investor, not so much.  “The analysts and ratings agencies typically estimate companies’ lease obligations by looking at their yearly expenses around that, and what IFRS 16 did is confirm whether their estimates were in the ballpark,” he says. “When it comes to private investors, they don’t typically look at those details, so I’m not sure it’s added a lot of insights for them.”   

However, according to Gavin Maze, where we do see real ROI of IFRS 16,and ASC 842 are in the efficiencies gained in managing leases. First, by being forced to centralize leases and to implement internal procedures and controls as part of the process, companies were able to right-size their lease holdings. “Advanced leasing technology naturally facilitated all that, discouraged incomplete information and provided a single source of truth across the entire organization,” Maze explains. “So, there are lots of analytics that can be run on their portfolio, finding opportunities for streamlining, revisiting lease models and real estate strategies to minimize costs.”

For CFOs who are in the first throes of accounting for leases on the balance sheets—whether that’s because they only now require an auditor’s opinion on their financials or are only now required to comply with the new standards—several key insights can be drawn from the lessons of their peers. Data is king, so data architecture is critical. In giving their standard processes new scrutiny, companies will find ways to refine processes for handling leases and gain insights into their lease needs. Critical, too, is to keep in mind that change can be smooth if managed well, with open communication, a collaborative mindset and a culture of adapatability.