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30 March 2017

Lease accounting terminology a Corporate Real Estate manager should know by heart

From 1 January 2019, the new lease accounting regulations from the Financial Accounting Standards Board (FASB) and the International Accounting Standard Board (IASB) will need to be implemented in order to comply with the new standards, ASC 842 and IFRS 16 respectively. In this blog, I will share with you the important lease accounting changes and relevant terminology.

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With effect from 1 January 2019, publicly listed companies will be required to include on their balance sheets all leasing contracts with a contract term longer than one year. This is a measure against an offensive strategy of sell-and-lease-back, also known as off-balance financing. It implies that organisations can free up financing, as leased properties – in contrast to owned properties – are not required to be included on the balance sheet. This strategy was used by many corporates during the 1990s and early 2000s. The key objective of the new standards are to enhance financial transparency in lease accounting administration.

Operating leases vs finance leases

Currently, operating lease obligations are not on the balance sheet but only disclosed as footnotes in an organisation’s financial statements. An operating lease is treated as operational expenditure only, based on straight lined payments, while a finance lease is a capitalised liability and right-of-use on the balance sheet, thus affecting profit and loss (P&L). Some organisations have chosen to own their real estate, on-balance, and others have chosen to rent their properties and assets as operating leases, off-balance.

Accountants have questioned this lease accounting practice for many years. How realistic are the financial statements on the balance sheet when an on-balance owned property or asset could be sold within a few months while an off-balance operating lease contract could represent a liability for many years ahead?

Enhancing financial transparency

The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) – both of which are bodies with the authority to define standards that organisations have to adhere to – are convinced that actual lease liabilities should be reflected in a uniform way for readers of financial statements. Since 2006, FASB and IASB have been undertaking a review of their relevant lease-related chapters ASC 840 and IAS17 that cover ease accounting. By moving away from current accounting practice, financial transparency will be enhanced by showing off-balance lease financing, together with the related liabilities, on the balance sheet.

 

From 2019, the relevant compliance standards are ASC 842 (which replaces ASC 840) and IFRS 16 (which replaces IAS17). However, even though the new reporting requirements take effect from 2019, at that same time, organisations must comply retrospectively to ASC 842 and IFRS 16 for the years  2017 onwards. Therefore, it’s time to act now, as 2019 is fast approaching! In my next blog, I will elaborate on the steps that a Corporate Real Estate manager will have to take, working together with their CFO, in order to be ready in time for the new lease accounting regulations.

Dr. David A. Martin
Business Development Director IFRS | Lease Accounting expert

Would you like to know how Planon can help to make your real estate and asset lease accounting compliant? Then please download our solution brochure.