Calendar year private companies and non-profits must implement the new US leasing standards effective January 1, 2021. Now is a great time to start before it is a mad rush at year end!
According to research by IFRS/FASB, 30,000 listed companies use IFRS or US GAAP. Off-balance sheet lease assets and liabilities approximate $2.18 trillion, which is the main reason these new standards are now required! It is estimated there are 6 million private companies in the USA, and this standard will apply to many. Don’t wait until the last minute as resources and lease software companies will be stretched!
Measurement of the right-of-use assets and the lease liabilities
Lease liabilities and right-of-use assets will be recognized on the balance sheet. The implicit interest rate for each lease is used to discount the lease liability and right of use assets calculated.
A lease liability is calculated as the net present value of the sum of the following:
- Fixed future payments for lease contracts, minus any lease incentives receivable over the lease term
- Variable payments linked to an index/rate base
- Amounts expected to be payable under residual value guarantees
- Exercise right of purchase option (If the lessee is reasonably certain to exercise the option)
- Termination penalties
The right of use asset can be determined from the net present value of the following:
- Initial value of the lease liability
- Lease payments made to lessor before the commencement date
- Lease incentives received
- Initial direct costs
- Estimated cost of removing and/or restoring the leased asset
How do you get started?
Step 1 – Identify Active leases
Hopefully, identifying leases will not be complicated for your business. What makes this more complicated is
- The number of active leases
- The lease standard itself
The standard is detailed and provides examples to determine contracts that contain a lease.
Step 2 – Read each lease and related documents to understand key terms and determine the type of lease; operating lease, sales-type lease, or direct financing lease
Each lease has its own unique terms. Obtain copies of each lease and related documents. These documents should be organized in folders, and key terms summarized.
Step 3 – We recommend using software to simplify lease calculations
A lease software solution will be beneficial:
- To summarize lease agreement key terms, rent payments and implicit interest rates to be used (each implicit rate used for a lease should be supported by appropriate documentation)
- For net present value calculations
- To create lease amortization schedules to determine the right of use asset and lease liability monthly values
- Summarizing monthly journal entries, including those to retained earnings if using modified retrospective adoption
- For lease analysis
- For footnote disclosure details
Using Excel or another manual method to obtain information detailed above is strongly discouraged. Not because it is too hard, but because tested and accurate cloud software programs are readily available for your use to save valuable time and effort. Also, manual calculations and schedules are a) subject to error, b) cumbersome when lease modifications are made at a future date.
Lease software available to our firm is subject to a SOC 2 Type 2 audit each year, including processing integrity, and is cost effective. Contact us for details.
Step 4 – Print supporting amortization schedules and monthly entries for the year for each lease
The schedules for each lease can be maintained in permanent files. Each time a lease is modified, added or terminated; the schedules are updated.
Step 5 – Reconcile your general ledger to supporting amortization schedules each month
We recommend starting early and, if software is utilized, both the implementation and audit effort can be simplified greatly.
We can help with either the software, the implementation, or ongoing support. Please contact us. Let’s get started!