by Brendan Doyle | 2020-12-22
The new lease accounting standards IFRS 16 (worldwide) and ASC 842 (USA) have entirely changed the principles of lease accounting.
Once adopted, companies must record all leases on the balance sheet, this including operating leases.
For public companies, the effective date was January 1, 2019. However, for private companies depending on your local reporting regulations, the standard may not be effective—for example, with ASC 842, the effective date for U.S. private companies is from January 1, 2022.
The number of leases in a company's portfolio is indicative of the impact of the new lease standard. One or two leases can be handled manually without overwhelming the finance team. The higher the number of leases, the more cumbersome the standard becomes. PwC stated, "For most companies, the significant changes to lease accounting mean that spreadsheet-based calculations will not be reliable or accurate enough."
Accuracy is not the only issue. Companies will need to ensure the completeness of lease data while providing a centralized and accessible lease database. This may have been overlooked when accounting for operating lease under the previous lease accounting standards due to its straightforward nature. An embedded lease classified as an operating lease can have a material impact on a company's balance under ASC 842 and IFRS 16.
Additionally, because of the material impact of the new lease accounting standard, lease administration is now crucial to ensure modifications are not overlooked and appropriately accounting for.
For further information on why the new standard was introduced, refer here.
A lessee must now recognize a right of use asset and a lease liability. The exemption to this rule is if the lease is shorter than 12 months or deemed low value (IFRS only).
There are several nuances when calculating the lease liability. The lease liability is the present value of the known future lease payments at a certain point in time. It also the starting point for the right of use asset valuation.
For a detailed guide of how to calculate the lease liability and right of use asset, refer here for ASC 842 and here for IFRS 16.
With the implementation of the new lease accounting standard, there is the opportunity to leverage technology to:
The lease accounting software solutions available in the market can automate the financial reporting requirements prescribed by ASC 842, IFRS 16 and GASB 87.
So how does lease accounting software work:
1) The user inputs the necessary contractual details such as payment frequency, payment amount, and other payment-related information.
2) Input the applicable accounting judgments, such as the discount rate and lease term.
From this data, the lease accounting software will calculate the value of the lease liability and right of use asset and generate your required journal entries for your accounting system. Another benefit of using lease accounting software is the ability to run all financial statement reports, including the necessary quantitative disclosures for your financial statements, instantly.
It's hard to differentiate between many of the solutions on the market. Pricing is incredibly opaque. Few companies provide actual screenshots and videos of their product. The easiest way to assess the software will be by requesting a product demo.
Given that demos are timely exercises, the first thing to do is shortlist your potential vendors. This decision will be based on two main inputs:
If you're comfortable that the lease accounting software can handle the fundamentals, you're ready to consider additional portfolio requirements. Not all companies will require all of these features, but the primary considerations should be the following:
All lease transactions are entered into to address a commercial need. For some companies, lease management software is imperative to staying on top of the commercial requirements of managing the lease portfolio. Given that lease management has been a problem companies have faced longer than the new lease accounting standards ASC 842 and IFRS 16, there are many more lease management software solutions on the market.
Some solutions have initially been created as a lease management tool and realized that accounting functionality is an important feature to offer. On the other side of the coin, you have solutions predominantly built for lease accounting and offer tools to manage a lease agreement.
Unlike lease accounting functionality, in which the accounting standards provide a clear guide of the features needed and the expected behavior, there are no set requirements for lease management.
If lease management is an essential aspect of the organization, some useful features will be:
If the software is well-engineered, it should come with the following features that you would see for any cloud product:
One of the best aspects of software is that it continually improves. When deciding on the appropriateness of the software it’s good to get an understanding of what features are on the development roadmap, the release date and how significant that feature will be to your portfolio. The timeliness of rolling out new features can vary widely depending on the company and its complexity.
Pricing for lease accounting software is incredibly opaque. As you have probably realized, very few companies put their pricing pages on their website. Fewer options offer a turnkey solution to sign up and get going like you would using other SaaS products such as email.
Once you've established your functionality requirements, the next step is to select vendors you believe meet these requirements and schedule a demo. It would be nice to include pricing into the selection criteria, but at the very least, you'll have to reach out to the applicable vendor to get a price estimate.
Once you've narrowed it down to a particular vendor, get a trial account, onboard some agreements, and ensure the software is appropriate for your lease portfolio.
From there, you'll need to weigh up the value offering and determine if the price warrants the additional features or other inputs that go into your selection criteria. There are numerous ways vendors charge for using their lease accounting software. Some of those are:
Due diligence is always recommended to understand the costs and potential for those costs to increase in the future.
The new lease accounting standards aren't going anywhere soon, so you will want to make sure you make the right decision. A little more time spent during the procurement process, such as getting a trial account and getting the buy-in from different departments, will pay dividends in the long run.
Cradle's lease accounting software has been precisely engineered to automate your compliance with ASC 842. With Cradle's transparent pricing and ease of use, skip the drawn-out sales calls and sign-up for a free trial.