Leasing is a $1.5 trillion global market that is projected to grow at almost 13% over the next few years. Lease accounting, therefore, is imperative for businesses worldwide to streamline operations and ensure better transparency and compliance with reporting standards. A lease, in essence, is a contract that separates the aspects of who the legal owner of an asset is and who will be using it. These agreements allow the lessee to use an asset in return for set periodic payments at a schedule of mutual choosing.
With the advent of technology, lease accounting, much like almost every other business function, has been facilitated substantially. Today, 85% of US companies have lease accounting software that manages their leases effectively. These tools allow more accurate reporting, minimal errors, and time efficiency. These software make it pertinent to report that 98% of companies have traditional spreadsheets to perform accounting. However, only 10% trust the accuracy of the information they provide.
Given the extent of the market, lease accounting is governed by reporting standards that are followed around the world. After nearly a decade in development, The Financial Accounting Standards Board (FASB), in February 2016, introduced a revised set of rules for the industry titled Accounting Standards Update 2016-02: Leases. One of the main purposes of these amendments was to address numerous critiques directed toward existing guidelines that lacked transparency and comparability clarity.
Here are some of the rules and what you need to know about them:
The Governmental Accounting Standards Board (GASB) is a body that regulates lease agreements that involve government agencies. It develops and implements the regulations for Subscription-Based Information Technology Arrangements (SBITA), and the GASB 96 is its most recent rule, instated in June 2022. Under these standards, financial reporting and accounting requirements for federal and regional administrative entities are established with regard to entering SBITAs.
In essence, an SBITA is a contract under which the government agrees to make periodic payments for access to a wide variety of IT and technology-backed resources like hardware, software, systems, and a host of others. It is one of the statutes that ensure transparency from the government toward its various stakeholders with regard to any arrangements that fall under SBITA. It mandates governments to give all concerned parties relevant and complete information about these agreements.
GASB 96 is a standard that requires any SBITA to be treated exactly like any other lease agreement, which means that the subscription asset that the government is receiving a right to use must be recorded both as a liability and an asset. The GASB 96 statement clearly defines rules and facilitates reporting guidelines on how these tech resources must be presented and measured on financial statements as assets and liabilities.
The Accounting Standard Codification (ASC) 842 became effective for public companies in December 2019 and for private entities in fiscal years starting from December 2021. The FASB replaced ASC 840 with the more comprehensive ASC 842 to ensure greater clarity and transparency into how companies are required to report leases, particularly on the liabilities section of their respective balance sheets.
The primary changes from ASC 840 to ASC 842 have been in terms of leases as liabilities. Under the new reporting standards, companies following the US Generally Accepted Accounting Principles (GAAP) must recognize the lease liabilities and assets for both finance and operating leases. It has changed how operating leases are classified because finance, previously known as a capital lease, was already recognized under ASC 840.
With ASC 842, both the legal owner of the asset (lessor) and the individual or company with the rights to use it (lessee) can go with practical expedients that do not mandate lessors to reassess any lease classifications. This makes compliance with these reporting standards much easier, and most owners or lessors are expected to elect for the expedient, allowing them a better as well as smoother transition to the new regulations.
Made effective in January 2019, the IFRS 16 is another accountant standard that concerns lease agreements. These reporting guidelines were introduced with two main goals, the first being an honest representation of any and all lease transactions. The second is with respect to transparency once again and offers a sound basis for all users of financial statements to analyze how financially viable the cash flow from the leases of a company is.
IFRS 16 necessitates lessees to recognize the lease liability, which is calculated on the basis of present values of expected lease payments. The lessee must also recognize a related right-of-use (ROU) asset against the liability. Concerning lessees, one of the biggest changes has been the introduction of the single model approach, where all leases will now be classified as financial leases. The operating lease classification for the lessee has ceased to exist.
For lessors, the dual model approach is still in effect, which entails that they are required to classify both finance and operating leases separately. The lessor has to apply the relevant accounting treatment for each after classifying which lease falls under which umbrella.
The difference between these two types of leases is primarily the transfer of ownership. In a finance lease, the lessor retains ownership, whereas, in an operating lease, the asset depreciation is recorded by the lessor while putting income from receipts as revenue following the straight-line method. Over time, the asset completely depreciates, eventually being written off from the balance sheet.
Another one of the guidelines concerning governments and their lease agreements is the GASB 87, which was implemented in June 2021. Administrative entities that follow these reporting guidelines must recognize both a lease liability and a related asset at the date when the lease commences. Lease liabilities are equal to the present value of expected lease payments spread over the term of the lease. The GASB 87 also uses a single model approach and now recognizes both liability and asset reporting in balance sheets for operating leases as well.
Compliance with lease accounting standards is mandatory for businesses operating in this realm. With the industry constantly evolving thanks to technological advancements, the reporting standards also require upheaval. The newest set of guidelines has focused on enhancing transparency concerning financial obligations, especially since globally, decision-makers are demanding clarity, accuracy, and honesty when reporting businesses' financial standing.