Post-Transition Policy and Procedure Considerations for Lease Accounting

by | Feb 27, 2023

Wondering what’s next after successfully transitioning to ASC 842? Whether a company is using a lease accounting software or has minimal leases to account for manually, it’s imperative to have policies and procedures in place going forward. To ensure your post-implementation efforts are seamless, identify all parties involved, refine the process and policies, and monitor the chosen lease accounting solution.

Establish lease accounting team

Know who will process leases after implementation

Teamwork is critical to continued compliance with the new lease accounting rules. During transition, you likely identified a point person to lead the implementation and a team to monitor all departments involved. This is also a good starting place to form a post-transition lease accounting team.

Consider the departments or people involved in the end-to-end leasing process. During implementation, organizations were more focused on gathering their complete lease portfolio and reporting the appropriate lease liability and ROU asset on their balance sheet rather than looking to future lease transactions. Now is the time to identify the other individuals, in addition to the accounting team, that will play a major role in the lease accounting process.

Many companies will transition to a centralized process to include multiple departments such as accounts payable, treasury, real estate, or legal. Establishing and identifying a cross-functional team is important to ensure all lease transactions are captured.

Work together to create an efficient process

Having a centralized process is great, but it requires everyone to work together efficiently. Consider if all parties involved will have access to the lease accounting software, and who needs read-only access versus change or approval rights. If lease accounting is tracked via manual spreadsheets, it’s important to ensure the data is secure and changes are tracked.

If multiple individuals are a part of the process, ensure responsibilities are clearly defined. For each function or department, identify a specific person or subject matter expert to follow any established procedures. Document what the procedures should look like for each function/department.

When new lease agreements arise, they should be reviewed thoroughly. Appoint a specific department the responsibility of scoping new lease agreements and contracts. Identify if an agreement is qualified as a lease or a service agreement that potentially has embedded lease assets as early in the process as possible.

The legal department will know of contracts being executed and the real estate team can monitor and verify if leases include complexities, such as subleases and sale-leaseback transactions. Accounts payable should reconcile payments made to the  lease accounting subledger regardless of whether a company is utilizing a lease accounting software or a spreadsheet. If your entity operates in multiple currencies, designate an employee to ensure exchange rates are accurate.

Finally, it will be the accounting department’s responsibility to

  • Reconcile the lease accounting subledger to the general ledger
  • Ensure all lease transactions are captured and correctly recorded
  • Post monthly lease accounting journal entries
  • Draft year-end financial statements and lease accounting disclosures

Training

Implement training for the departments involved to build the necessary technical accounting expertise. With the complexities of the lease accounting standard, companies may need to educate their current accounting team as hiring leasing specialists may not be an option. This results in the need for companies to invest in post-implementation training to expand their lease accounting expertise.

Additionally, the accounting standards are always evolving and new guidance updates are periodically issued, so it’s important to provide education post-implementation. Training should also cover the established internal processes of each organization and the selected software’s functionality.

Process & policies refinement

Evaluating new contracts for leases

It’s critical to account for all leases. Some of those leases are hidden within service contracts or larger agreements, known as embedded leases. The best practice is to ensure processes are established to identify and properly account for them. This process requires investigation and contract analysis. Consider adding these steps to the lease accounting process to aid in identifying embedded leases:

  • Assess service contracts within relevant departments
  • Examine contracts with the help of the legal department
  • Review areas of high-risk for unrecorded embedded leases

Data abstraction

Accurate lease accounting requires capturing the correct data points from contract execution to lease expiration. Sifting through hundreds of pages of lease agreements is challenging but abstracting the correct data is essential as it will impact all calculations from lease commencement to the end of the lease term.

Data abstraction is critical to creating accurate and complete financials as it plays an important role in the initial recognition of the lease liability and right-of-use asset on the balance sheet, in addition to future lease changes such as modifications and renewals. Multiple amendments or reassessments may occur post-implementation and each lease transaction requires data abstraction. To avoid a large volume of year-end lease adjustments, it’s imperative to have a stringent policy in place to collect accurate data points.

Data abstraction post-implementation should be seamless and build upon the lessons learned during initial implementation. We recommend identifying data points that were previously difficult to retrieve or validate and then building controls around the process going forward.

Evaluation of discount rates

Private companies are permitted to use the rate implicit in the lease, incremental borrowing rate, or the risk-free rate to measure the lease liability and corresponding right-of-use asset. However, the implicit rate is not usually specified within the contract and rarely used by lessees as they generally do not have all of the information necessary to calculate this rate.

The implicit rate is readily available for lessors as they utilize this rate to compute their return and drive profits from their leases. Many private companies have elected the optional practical expedient to utilize the risk-free rate to calculate the lease liability since determining the incremental borrowing rate is complex and time consuming.

Post-transition, discount rates should be determined as of the commencement date of each new lease. However, the majority of companies do not establish a new discount rate each time they enter into a new lease. Instead, a common practice is to update the discount rates on a quarterly or monthly basis. Organizations should refine the processes surrounding the determination and frequency of updating discount rates.

Lease change policy/procedure

In addition to the monthly journal entries for leases existing at transition, post-transition lease accounting involves recording any lease changes. Establish processes to record each change accurately. Create reminders or critical date alerts for renewals, rent escalations, and the end of the lease term. Determine the accounting treatment for purchase options, terminations, and other lease transactions.

Amendments or other updates to a lease can trigger a modification or remeasurement or result in a new lease or a termination of a lease. It is important to establish procedures to ensure appropriate personnel is alerted to lease changes so they can evaluate the accounting impact. Then designate a person/people to process changes and a second person/people to approve those changes.

Ongoing compliance

Accurate calculations

Manually calculating accurate updates to amortization schedules with consideration for any lease changes is a cumbersome process. One way to reduce the risk of human error and ensure accurate lease accounting calculations post-implementation is to use reliable lease accounting software. For those currently using software, be sure to obtain your vendor’s annual SOC 1 Type 2 report to verify the provider’s internal controls over financial reporting are suitably designed and operating effectively.  Applying regular testing of system outputs is also a recommended best practice.

Data management

Extensive lease data collection and documentation is required prior to, during, and after implementation. Leverage the information gathered for transition by storing it in a central repository located on the cloud, in a shared drive, or in an equally accessible location. After transition, establish a process to compile and store new lease contracts, amendments, and any other necessary lease data and information.

Organizations will want to utilize one application to keep track of critical dates and other important lease data, such as renewals, rent escalations, and purchase options. It’s important to note that all payments, including variable payments not included in the initial measurements of the lease liability, must be reported in the notes disclosures so organizations will also need a way to account and track these

Some software has these capabilities built-in, or an organization may have a specific location to track those dates and all of their lease data. A major benefit of lease accounting software is having all information stored within the software, including the lease documents. Post-implementation, this gives auditors and any relevant departments the ability to access necessary information quickly and easily.

Lease changes: Modifications, renewals, terminations, impairments

In addition to posting the monthly journal entries for leases existing at transition, lease accounting after transition will include recording any lease changes occurring post-implementation. Consider what it looks like to account for multiple lease changes via Excel or within a lease accounting software. The team must be knowledgeable in applying those changes including modifications, renewals, or terminations via the software or performing the accurate calculation via Excel.

It’s important for all of the involved teams to be in communication monthly or at regular intervals so the appropriate personnel are aware of the nuances or changes that occur within the organization’s lease portfolio. Once parties have been notified, steps can be taken to apply the appropriate accounting.

Financial reporting

Ultimately, the updated lease accounting standards will result in better financial reporting. As a side effect, organizations will also experience more accurate budgeting, planning, and forecasting in the future. Departments other than accounting, such as procurement and the financial planning and analysis team, will be able to perform deeper analysis and gain more visibility into the details of their leases.

Organizations using a centralized lease accounting software will have the ability to create customized and detailed reports. The auditors will benefit as they’re able to review seamlessly generated disclosures and all support will be available in a central location.

Summary

Overall, it’s imperative organizations consider post-implementation policies and procedures to ensure their lease accounting continues to be in compliance with the new standard going forward. Having a seamless approach includes identifying a lease accounting team, refining your lease accounting process and policies, and planning maintenance activities to ensure ongoing compliance.

LeaseQuery is here to simplify your post-transition lease accounting. Schedule a demo today to learn more.

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ASC 842 Lease Accounting Guide