If you are accustomed to tracking your leases in a spreadsheet or your real estate administration system, the concept of a lease accounting application might be new to you. And you may be wondering – what exactly are the key capabilities of a lease accounting software application? Some features are obvious. For example, the software needs to be able to perform the proper accounting under the new lease accounting standards (FASB ASC 842). Most critical to supporting the standards will be the need to generate the necessary journal entries required to report your leases as assets and liabilities on your balance sheet. To arrive at the journal entries, you will need an accounting engine and a database that can store the key terms and conditions for each of your leases – base and variable rent; start and end dates; end of term options.
But beyond these basic features, what else should you look for in a lease accounting software application? Below are the seven key features we recommend enterprises consider for their lease accounting software:
Lease Accounting Software Features – The Seven Key Capabilities to Look For
1) Lease Classification
Under the new FASB standards, leases will be required to be classified into “operating leases” or “finance leases” with some exceptions for Short Term leases. The new IFRS standards classify most leases as “finance leases” with exceptions for “short term leases’ and “low value leases.” Lease accounting software should allow you to perform classification testing based upon a set of policy thresholds that you configure. For example, you might set policy thresholds for bargain purchase options; renewal periods likely to be exercised; or the percentage of payments that represent an asset’s Fair Market Value. Additionally, lease accounting applications should allow accountants to record notes about judgments related to the classifications. And users should be able to record comments and explanations for overrides of the test results.
2) Non-Real Estate Asset Support
Most lease accounting applications were designed primarily for real estate. But chances are good that 20% or more of your leases are non-real estate assets such as shipping containers, networking equipment, IT infrastructure, personal computers, office furniture or company cars. Ask your software vendor if they support not only Gross and Net Leases, but the types of lease structures popular with IT, Fleet and Equipment lessors. Examples include Fair Market Value, Dollar Out, TRAC, Split-TRAC and Deferred Leases. Ask your software vendor if they support not only performance (e.g. sales/revenue) and index-based (e.g. CPI) pricing popular in real estate contracts, but usage based pricing for equipment as well. You will want to be sure you can account for photocopier leases that bill by the page or truck leases that charge by the mile.
3) Lease Accounting Sub-Ledger
Most companies will not want to clutter up their general ledger with detailed accounting entries for each of their leases. This is especially true for companies that are leasing 5,000, 10,000 or 50,000 different assets. Much like you have a sub-ledger for payroll, receivables, inventory, fixed assets or travel expenses, you may need one for leases as well. In the lease accounting sub-ledger you will record all your journal entries such as commencement, expense recognition, principal reduction, short term and long term re-classifications. Of course, you won’t generate your full income statement or balance sheet from your leasing sub-ledger. But you can upload the debits and credits into your General Ledger, which will be used to generate the necessary financial disclosures.
4) Asset Level Tracking
The new lease accounting standards require you to report assets (not schedules) and liabilities on your balance sheet. You might have a single lease schedule that contains 50 separate computer assets. At the end of the lease, you may want to return 20 of the computers, purchase another 10 and extend the lease for the remaining 20. Your accounting system will need to be able to manage these partial buyouts and returns at the asset-level. The need for asset-level reporting is a common misunderstanding amongst lessees, lessors and software vendors. Be sure to check that your lease accounting software vendor can account for leases at an asset, schedule and portfolio level.
5) Comparative Reporting
The implementation deadlines for the new lease accounting standards do not start for public companies until 2019 with private companies following one year later. But if you read the fine print of the implementation guidelines you will note that the reporting disclosures also require companies to provide comparative reporting during the transition period. Companies following US GAAP will be required to provide three years of comparative reporting for income statements and two years of comparative reporting for balance sheets. For example, you will need to be able to show how your incomes statement looked before and after the new accounting standards for 2017. That means that your lease accounting software will need to be able to support both the current standards (ASC 840) as well as the new standards (ASC 842). Be sure that your lease accounting software will enable you to track multiple sets of books during the transition period.
6) ERP General Ledger Integration
The outputs of your lease accounting sub-ledger will need to be uploaded into your ERP’s General Ledger to generate a full corporate balance sheet, income statement and other necessary financial disclosures. The upload of debits and credits from your lease accounting application to your ERP should be relatively easy and painless. Be sure that your lease accounting vendor has experience integrating with your GL package whether it is from SAP, Oracle, Microsoft, Sage, NetSuite or another vendor. Explore what types of integration options are available such as RESTful APIs, point-to-point integration or simply “flat file” uploads.
7) IFRS 16 Support (Optional)
Although the FASB and IFRS lease accounting standards are very similar there are some important differences to note. If you are an IFRS filer, be sure to ask your lease accounting vendor if their application is compliant not just with the ASC 842 guidelines but with the IFRS 16 rules as well. For example, the new IFRS rules allow for different treatment of low-value leases (less than $5000). Income statement treatment differs between the US GAAP and IFRS. And the rules on how to account for variable lease payments and how to determine the initial direct costs vary as well.