Beginning January 1, 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, respectively ASC 842 and IFRS 16. In this blog, I will share with you the important lease accounting changes and corresponding terminology.
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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.
With effect from January 1, 2019, publicly listed companies will be required to include all leasing 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, which implies that organization’s leased properties – in contrast to owned properties – are not required to be included on the balance sheet. Many corporations applied this strategy during the 1990s and early 2000s. The key objective of this new standard is to enhance financial transparency in lease accounting administration.
Operating leases vs finance leases
In the current situation, operating lease obligations are not on the balance sheet but only disclosed in the footnotes on the organization’s financial statements. An operating lease is treated as an operational expenditure only, based on straight-lined payments, while a finance lease is a capitalized liability and right-of-use on the balance sheet, thus 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 lease, 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 multiple years ahead?
Enhancing financial transparency
The Financial Accounting Standards Board (FASB) and allied International Accounting Standards Board (IASB) – both of which are bodies with the authority to define standards that organizations have to adhere to – are convinced that the actual lease liabilities should be reflected in a uniform way for users of the financial statements. Since 2006, FASB and IASB have been working to review their relevant lease-related chapters ASC 840 and IAS17 on lease accounting. By moving away from the current accounting practices on off-balance lease financing and having the liabilities that leases incur be represented on the balance sheet, financial transparency is enhanced.
As of 2019, the relevant accounting standards for compliance preparations will be ASC 842 (which will replace ASC 840) and IFRS 16 (which will replace IAS17). However, even though the new reporting requirements are due for 2019, they will also require retroactive reporting that is compliant to the new standards from 2017 on. Therefore, now is the time to act, as 2019 is fast approaching! In my next blog, I will elaborate on the required steps CRE managers must take, in collaboration with their CFO, in order to be ready in time for the new lease accounting regulations.
Dr. David A. Martin
Business Development Director Planon IFRS | Lease Accounting expert
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