March 30, 2017

New regulations require new insight | Lease accounting terminology a CRE manager should know by heart

From 1 January 2019, new lease accounting regulations from the Financial Accounting Standards Board (FASB) and the International Accounting Standard Board (IASB) had to be implemented to comply with the new standards, ASC 842 and IFRS 16 respectively. In this blog, we will dive into these important lease accounting changes and relevant terminology to be aware of. 

Webinar - How the new lease accounting standards will impact your business

Organisations need to be prepared now to remain compliant when the new regulations come into effect on January 1, 2019. View this webinar to get informed about the changes and how you can prepare. 

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Effective January 1, 2019, publicly listed companies are now required to include all lease contracts with a contract term longer than one year on their balance sheets. This is a measure against an offensive strategy of sell-and-lease-back, also known as off-balance financing. Previously it was implied that organizations could 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 corporations during the 1990s and early 2000s. The key objective of the new standards is to improve financial transparency in lease accounting administration.

Operating leases vs finance leases

Until this year, operating lease obligations were not included on the balance sheet but simply disclosed as footnotes in an organization’s financial statements. An operating lease is treated as operational expenditure only, based on straight lined payments, while a finance lease is a capitalized liability and right-of-use on the balance sheet, consequently affecting profit and loss (P&L). Some organizations 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 organizations are required to comply with – 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 lease-related chapters ASC 840 and IAS17 that cover lease accounting. By moving away from previous 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). Even though the new reporting requirements took effect this year, organizations must still comply with ASC 842 and IFRS 16 for the years 2017 and beyond. It is now well-known that the introduction of IFRS 16 has had major reporting consequences for companies with off-balance contracts. The implementation has often taken six to nine months because the new IFRS standard requires input from many departments. This has had a huge impact on the timely and accurate implementation of IFRS 16. In fact, without the correct data on property and lease contracts, a compliant and cost-efficient implementation of this new standard by January 2019 was simply impossible. The answer lies in combining Integrated Workplace Management System (IWMS) software and IFRS 16 compliancy within one solution. Why? In a previous blog, my colleague David Stillebroer, Director Product Management, explained the main organizational benefits.