By Emily Fish, director of product accounting at LeaseQuery
Within the lease accounting standards, there are exceptions to help entities determine which leases are in scope and which are not.
First and foremost, the lease accounting standards apply to all entities—there isn’t an exception for an entity or industry as a whole. Instead, exceptions are applied on a lease-by-lease basis depending on certain policy elections:
- ASC 842, IFRS 16, and GASB 87 all have exceptions for short-term and immaterial leases. A short-term lease is one that spans 12 months or less from start to end date. An “immaterial” lease is a little less clearly defined.
- Entities reporting under ASC 842 can make a policy election to determine what they deem material, as the FASB did not provide a set dollar value for this exception and instead just said it had to be “reasonable.” In some cases, entities will choose to mirror their capitalization threshold for fixed assets. That is, if they don’t capitalize a fixed asset less than $25,000, they would not include a lease with a total liability of less than $25,000. There are a few ways to evaluate those capitalization thresholds.
- IFRS 16 is a little more straightforward in that it allows a value of $5,000 to define a lease as “low-value” (aka “immaterial”).
- Under GASB 87, governments are able to determine their own materiality thresholds for purposes of scoping the lease standard application. There is significant diversity in practice as to what governments deem material and immaterial. For these short-term and immaterial leases, entities will not recognize a right-of-use asset or lease liability. To remain compliant, they will instead recognize expense on a straight-lined basis as they did under the previous standard.
As with any accounting policy, documentation is key. It’s important for leadership to take the time to write a memo clearly defining their policy elections and provide a rationale for the conclusions they’ve reached. This will speak to the “reasonableness” of the policy election and provide continuity in practice.
The incentive to stay compliant is to not have to deal with the consequences of not being compliant. The guidance is clear—you have to adopt. The consequence of non-compliance is basically a loss of confidence from the entity’s stakeholders. For governments, non-compliance could affect bond ratings and bond issuances. For public companies, this can mean a qualified opinion from an auditor which could affect investor confidence. For private companies, non-compliance could have a negative impact on credit ratings and scare off lenders. And if that company has intentions of going public at some point, there could be long-term implications.
Almost everyone has been affected by the new accounting standards. But in certain circumstances, some may have been affected more than others. Smaller companies with less leases would potentially want to scope out short-term or immaterial leases for simplicity’s sake—it’s less to track. However, smaller companies are more likely to have lower capitalization thresholds and not be able to scope out immaterial leases. Larger companies, which have the technology in place to centralize their leases, may have a higher capitalization threshold and elect to scope out immaterial leases, but they may want to have all of their leases in one place, again for simplicity’s sake—it’s less to track separately.
Regarding the lease standards, there are two main ways to stay compliant. The first way to stay compliant is to periodically review your documentation to ensure you’re doing what you said you’d do, and not doing what you said you wouldn’t do. Hopefully much thought and consideration were given when these elections were documented, and as such, you should be following your own guidelines.
The second way to stay compliant is to constantly review your lease population for completeness. If contract execution is not centralized in your organization, check with your business partners to ensure you know about any leases they’ve signed since your last check in. Many organizations went through a rather labor-intensive review of all of their contracts to ensure they had a complete lease population upon adoption, and that review should continue periodically. A “complete” lease population not only means knowing about the existence of all leases, it also means capturing any changes to any existing leases—renewals, modifications, impairments, terminations, etc.—and updating the calculations in a timely manner.
ABOUT THE AUTHOR
Emily Fish is the director of product accounting at LeaseQuery. Emily serves as the technical accounting resource to managed service clients. She is also responsible for testing key accounting functionality within the software to ensure compliance with accounting guidance and designing workflow for product enhancements.
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