New lease accounting requirements could catch companies unaware

lease accounting

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Radical changes to the way in which companies must account for leased assets will require action much sooner than many realise, as Ann Furlong explains.

The new rules, which come into force from 1 January 2019, will require companies to transfer the value of leases onto their balance sheets as liabilities. However many will actually need to be prepared from 1 January 2018 to allow for year-on-year comparisons.

Named the International Financial Reporting Standards (IFRS) 16, the rules have been developed by the International Accounting Standards Board with the objective of them being applied on a globally consistent basis. It is envisaged this will give investors the ability to compare the financial performance of publicly listed companies on a like-for-like basis with others around the world.

Increased administration

The changes are likely to significantly increase administration workloads for companies in the lead up to January 2019. Details of leases are often stored in paper form, meaning data will need to be extracted and entered into financial applications for processing.

For large companies this is potentially a massive task and the amounts involved could run into the billions of dollars. Thousands of leases for everything from property and computers to phones and heavy machinery will need to be examined and relevant details added to balance sheets. While the task may be different for smaller companies, the requirement remains the same. Details of all lease obligations must be shifted from ‘off book’ to being recorded as a liability on the balance sheet.

The Borders incident   

The origins of the new regulations can be traced back to problems suffered by book retailer Borders in 2011.

According to a report by the Australian Accounting Standards Board, the company was unable to terminate some of its $US 2.8 billion operating lease commitments to protect its profitability. At the time, those commitments represented about seven times Borders’ reported debt.

The AASB says defaulting on operating lease commitments played a significant part in the downfall of the company and resulted in calls for those obligations to be brought onto an entity’s balance sheet and treated in the same way as other debt.

Improved transparency

In essence, the new requirements around how leases are incorporated into balance sheets will provide much better transparency for companies and investors. They will serve to remove the guesswork that has been traditionally needed when dealing with lease obligation assessment.

The changes will also make it much easier to compare companies where one has chosen to lease certain assets while another has opted to purchase. This will change things for companies who might previously have used leases to hide liabilities and make their balance sheets appear more favourable.

A looming deadline

While the new regulations come into force from January, 2019, organisations need to make preparations well before that date. In many cases, companies are required to do year-on-year comparisons and so a system for shifting the lease obligation details onto the balance sheet must actually be in place by January 1 of 2018. For this reason, preparations need to begin as quickly as possible.

The majority of companies are likely to be aware that the changes are coming, however far fewer have begun the work that will be required to reach compliance. Significant effort will be required by finance teams to located the required lease information and enter it into financial systems.

Care must also be taken to enter the correct information in the correct format. The finance team must take care to recognise all lease assets and lease liabilities in the balance sheet. They must also recognise depreciation of those assets and the interest paid on them.

The teams must also take steps to present the amount of cash paid for the principal portion of the lease within financing activities and the amount of interest paid in the cash flow statement.

Making use of external assistance

The significant workload increase cause by the new provisions is going to put pressure on finance teams where, at least in the short term, more resources will need to be added.

Indeed, to ensure processes and systems are in place to meet the 1 January 2019 deadline, most organisations are going to need to solicit external expert support. This can help to guide the data extraction process as well as ensure it is entered correctly into financial records.

Once the data has been entered, software can be put to work to streamline ongoing reporting and ensuring compliance with the new regulations. For example, tools from BlackLine can calculate interest, update journals and do reconciliation.

By seeking advice and assistance from an external expert now, and deploying effective supporting software tools, such as BlackLine’s cloud platform, companies can avoid a rush and ensure they are best placed to meet their compliance requirements well before the 2019 deadline.

Ann Furlong is director of operations, Asia-Pacific, BlackLine.

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