Over the last few years, we’ve discussed the impact of ASC Topic 842 Lease Accounting on financial statements. Discounted lease liabilities and corresponding assets will be required to show on the balance sheet.
Finance type leased assets will incur amortization and interest expense, while operating leases will be expensed through a lease expense account. Organizations with even a small lease portfolio will need to manage lease liability schedules for each lease. Many will opt for a lease accounting system to track and maintain these schedules. This article discusses what happens after the lease information has been gathered and leases have been added to the financials.
Each month, an activity entry will be created to report reductions to the asset and liabilities, along with expenses related to those leases. The final portion of the entry is a credit to accounts payable for the payment of the lease. The lease accounting system could create the payable in the accounting system, or it could apply the payment portion of the entry to a clearing account. If the clearing account method is used, the lease portion of the accounts payable invoice entry would also need to hit the clearing account and not the lease expense. The lease expense will be calculated and applied from the lease accounting system entry.
There are many reasons using a clearing account option may be more desirable. First, an invoice could be received from the vendor, and if entered in addition to the invoice created from the lease accounting system, there is a risk of doubling the expense. Second, the invoice amount may not tie exactly to the lease system due to variable type items, non-lease components, or late fees, for example. Even though many lease payments will tie to the payment exactly, some will not, causing an accounts payable nightmare. Finally, there may be a timing difference between the lease accounting system and the invoice payment date. The invoice may need to be paid prior to the month the payment relates to. For all these reasons, there will need to be a reconciliation process between the lease accounting system and the actual payments made for appropriate reporting of the expense.
Beyond accounts payable, this reconciliation may also capture adjustments required in the lease accounting system, if they were not identified sooner. Ideally, the operations team is trained on the lease accounting system so they can update changes in the life of a lease in real time. Some of the changes impacting the lease schedule include expansions of space, renewal or extension of the lease, renegotiation of lease terms, or early termination of a lease. These changes can be entered by the lease users and reviewed by the accounting department prior to the finalization of the journal entry. If the update doesn’t happen timely, the reconciliation should flush out changes in the leases not previously recognized.
The last control step that should be considered is a completeness test, as this will assure there are is not an excess of unreported leases. Reviewing expense accounts for reoccurring, consistent payments can help uncover leases that had not been correctly reported in the lease system. This is a step the external auditors will take, so to avoid excess adjusting entries; the completeness test is often in an organization’s best interest.
As you step down the road of ASC 842 lease accounting, recognize there are many departments outside of the accounting team that will need to be involved in maintaining the lease accounting requirements. The sooner the start of the conversation, the better. Consider making lease training a part of onboarding employees who may be involved or impacted.
Organizations need to find a suitable solution for calculating the FASB ASC Topic 842 right-of-use assets and lease liabilities at the transition date and the subsequent lease accounting. Generally, an Excel-based solution would be appropriate for a noncomplex portfolio of 10 or fewer leases. If the lease profile is more complex or greater than 10 individual leases, management is better served by a lease software solution, such as simpLEASE. In addition to offering our clients simpLEASE, Schneider Downs provides advisory services for the technical aspects of lease accounting. For more information concerning lease accounting and the impact on your organization, please visit the Schneider Downs Our Thoughts On blog or email us at [email protected].
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.