Accounting standards for long-term leases, which are leases longer than twelve months, are undergoing major changes that affect any organization, which either leases anything (property or non-property) or receives income from leases. It is important for business owners and senior management to understand the changes made by the American Financial Accounting Standards Board (FASB) in accordance with new accounting rules under Generally Accepted Accounting Principles (GAAP) and similar provisions of the International Financial Reporting Standards (IFRS).
Revenue Recognition and Long-Term Leases
It is Time to Prepare to Be in Compliance
These new rules go into effect for public companies in 2018 and for private companies in 2019. Early adoption of the rules by any company is optional.
If the subject of revenue recognition is new to you, in order to understand the basics about the changes in the revenue recognition rules, please review the five-step process of revenue recognition and how the new rules affect the construction industry.
In a previous post for property managers, we noted how new revenue recognition rules require any property lease that is longer than 12-months to be reported on the balance sheet and no longer on the profit and loss statement.
Changes Affect Both Lessors and Lessees
Companies that lease properties under long-term leases need to report the lease obligations as a liability on their balance sheet. Both lessees and lessors will now have to report any long-term lease on the balance sheet. This includes both property and non-property leases. By reporting a lease as a long-term liability on the balance sheet, it shows whether or not a particular company is over-leveraged.
Under the Accounting Standards Update (ASU) from FASB, which is No. 2016-02, Topic 842 – Leases, companies are required to report leased office space, equipment, storefronts, vehicles, and any other types of lease arrangements as assets and the lease payments they make as liabilities.
Things can get a bit complicated if a business has long-term service agreements or long-term outsourcing contracts with third-party vendors. These types of agreements, which qualify as leases, require in-depth analysis to determine the proper method of revenue recognition. Revenue recognition for lease management companies is also somewhat complex.
Steps to Take
Step One: The first step is to engage a professional firm that has experts in the area of revenue recognition, such as those at Palazzo, Inc. A discovery team will conduct a full review of all lease contracts for property and non-property to determine the financial calculations needed for proper revenue recognition under the new rules.
Step Two: In addition to reviewing traditional lease arrangements with this process, these experts will undertake a comprehensive review of other contracts, which have “lease-like” characteristics, such as service agreements and outsourcing contracts. Sometimes a professional evaluation needs to set a standard for a particular arrangement because the new rules rely on determining the element of control a particular party has over the property or non-property, not just whether lease payments have been made. This determination may require a judgment call based on in-depth knowledge of industry standards.
Step Three: New accounting procedures and protocols are put in place so that the company is able to stay in compliance with all future lease transactions.
Step Four: The company’s financials are re-calculated after the adjustments are made.
Step Five: The audit firm for the company checks the new accounting allocations for leases and verifies the accuracy of the calculations as part of the regular audit procedures.
Many companies are rapidly moving ahead with comprehensive, company-wide contractual reviews and implementing procedural changes in accounting methods, in order to be prepared to be in compliance by the deadline. Others are just getting started.
The professionals at Palazzo Inc. highly recommend taking a proactive approach in dealing with these changes, in order to avoid any unfortunate consequences that may occur by not being in compliance with the new rules on time. It is also important to understand the “trickle-down” effect of these changes and calculate the financial impact on the bottom line. Contact the experts at Palazzo Inc. today, for an assessment of your current situation.
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