Tablespoon and FinQuery presented on Lease Accounting in the Restaurant Finance Monitor's Restaurant Real Estate Week Webinar Series, covering The Why, How, and When to Automate Your Leases.
During the session, they discussed:
- Why should restaurant groups care about lease accounting?
- Lease accounting can be complex and not just for publicly traded companies.
- Where does the complexity come from?
- Leverage Technology & Automation: Why does integration matter?
- When is the right time to automate your lease accounting?
Below are some key takeaways about lease accounting from Tablespoon's Andrew Lester, MJ Mahood, and FinQuery's Jaron Moss.
Why should restaurant groups care about lease accounting?
Restaurant groups, due to the nature of the business, face lease terms that can chip away at their profit margin, which can ultimately make or break the business. So, the FASB ASC 842 standard aims to improve transparency by bringing the majority of the operating leases to the balance sheet. This requires restaurants to inventory all their leases, including many equipment leases.
Lenders are also a driving force behind the adoption of Generally Accepted Accounting Principles (GAAP) requirements. Whether you are running a public or private establishment, your restaurant group must incorporate GAAP into its business processes. One common misconception about compliance with ASC 842 is the belief that it's a one-time event. However, achieving compliance is an ongoing process, and restaurants must track and document leasing information to remain compliant. Failure to do so can significantly impact business controls, processes, and the bottom line.
In addition, lease accounting is essential because accounting departments face a significant challenge in complying with ASC 842 regulations when done manually, which increases the risk of errors. According to FinQuery, restaurants have seen up to a 1,300% increase in average lease liabilities with the new lease accounting rules. Lastly, changes in lease structures due to COVID-19 have made accounting challenging without a technology solution.
Lease accounting can be complex and not just for publicly traded companies.
Lease accounting can be complex for all types of organizations. This is due to new lease standards adopted in 2022 by private and non-private companies.
The 2022 US GAAP included:
- Requirements for balance sheet entries for both operating and financial leases
- Valuation of the lease liability and a right-of-use asset
- The unwinding of liability and amortization of the asset
- Modifications and remeasurements
Adding training programs for your team and developing efficient processes can also contribute to the complexity of your operations. This includes:
- Controls
- Policies and processes to reduce the risk of leases
- Well-documented process manuals and guides to support the most common decisions and procedures relevant to your portfolio
This isn't a set-it-and-forget-it thing. You need to stay on top of it.
Where does the complexity come from?
Lease accounting can be complex due to various factors, including the accounting standards, the nature of lease agreements, and the need for accurate financial reporting. Complexity arises as you deal with it manually. Teams may be overwhelmed, confused, or burdened.
When dealing with lease accounting, you have to consider:
- Lease Classification: Determining whether a lease should be classified as a finance lease or an operating lease. The classification affects how lease assets and liabilities are recognized on the balance sheet.
- Initial Recognition and Measurement: Calculating the present value of future lease payments to determine the initial recognition and measurement of the lease liability and right-of-use asset.
- Discount Rate Determination: Selecting an appropriate discount rate for discounting future lease payments to their present value. This rate is often the incremental borrowing rate but may be challenging to determine accurately.
- Variable Lease Payments: Assessing and accounting for variable lease payments, which can include costs such as maintenance, insurance, or taxes, and may complicate the calculation of the lease liability.
- Lease Modification: Handling lease modifications, such as changes in lease terms, payment amounts, or changes in the scope of the leased asset. These modifications may require a reassessment of lease terms and financial impact.
- Subleases and Right-of-Use Asset Impairment: Accounting for subleases and evaluating potential impairment of the right-of-use asset, especially if the fair value of the underlying asset has decreased.
- Transition to New Lease Accounting Standards: Transitioning from previous lease accounting standards (e.g., ASC 840) to the new standards (e.g., ASC 842 or IFRS 16) can be complex and may involve retrospective or modified retrospective approaches.
- Lease Term Determination: Determining the lease term includes assessing options to extend or terminate the lease and factoring in renewal options and termination penalties.
- Lease Data Management: Managing and tracking a large volume of lease data, including lease agreements, payment schedules, and related documentation. This complexity increases with a diverse and extensive lease portfolio.
- Disclosures and Reporting: Providing the required disclosures in financial statements, including information on lease liabilities, right-of-use assets, and other relevant details. Meeting these disclosure requirements can be intricate.
- Operational Challenges: Integrating lease accounting processes with other financial systems, ensuring accurate and timely recording of lease-related transactions, and maintaining compliance with accounting standards.
- Complex Lease Structures: Dealing with complex lease structures, such as sale and leaseback transactions or build-to-suit arrangements, which may have unique accounting considerations. The complexity in lease accounting arises from the need to adhere to accounting standards, accurately reflect the economic substance of lease transactions, and ensure transparency in financial reporting. As a result, organizations often need specialized software, professional expertise, and thorough documentation to navigate the intricacies of lease accounting successfully.
When it comes to dealing with complex leasing situations, we often find ourselves in a love-hate relationship with Excel.
Excel Pros:
- Readily available
- Full control of data, configuration, etc.
- Low cost
- Flexibility in creating your own calculations/customizations
Excel Cons:
- Error-Prone Manual Entry: Excel relies heavily on manual data entry, making it susceptible to errors. Incorrect input of lease terms, payment schedules, or other critical data can lead to inaccuracies in financial reporting.
- Version Control Issues: Collaboration on Excel sheets can lead to version control problems. Multiple users working on different versions of the same file may result in confusion, errors, and difficulty tracking changes.
- Limited Automation: Excel lacks the advanced automation capabilities required for complex lease accounting. Processes like automatically calculating present values, managing lease modifications, and handling complex calculations can be time-consuming and error-prone.
- Difficulty in Scalability: As the volume of leases increases, managing them in Excel becomes more challenging. Excel may struggle to handle large datasets and complex calculations, limiting scalability as the lease portfolio grows.
- Data Integrity and Security Concerns: Excel files are prone to data integrity issues, and there is a risk of accidental data loss or corruption. Additionally, Excel lacks robust security features, potentially exposing sensitive lease information to unauthorized access or changes.
- Difficulty in Compliance: Ensuring compliance with evolving lease accounting standards, such as ASC 842 or IFRS 16, can be challenging in Excel. Managing complex lease terms, categorizing leases accurately, and generating compliant financial reports may require additional effort.
- Difficulty in Auditing: Auditing lease data in Excel may be challenging due to the lack of automated audit trails and comprehensive reporting. This can impact the accuracy and reliability of financial statements during audits.
To overcome these challenges, many organizations opt for dedicated lease accounting software or integrated enterprise resource planning (ERP) systems that offer specialized functionalities, automation, and enhanced security for managing leases in compliance with accounting standards. These systems provide a more robust and scalable solution for lease management compared to Excel.
Leverage Technology & Automation: Why does integration matter?
Integration allows restaurant groups to maximize the number of technologies used to create seamless, more efficient business processes and user experiences while eliminating human error.
Benefits of leveraging technology and automation for lease accounting:
Accuracy and Compliance:
- Automation reduces the likelihood of human errors in lease accounting calculations, ensuring accuracy in financial reporting.
- It helps organizations comply with lease accounting standards, such as ASC842 and IFRS 16.
Time and Efficiency:
- Streamlines the lease accounting process, saving time and effort compared to manual calculations and data entry.
- Enables faster lease data collection, validation, and reporting.
Audit Trail and Documentation:
- Provides a comprehensive audit trail, documenting lease transactions and changes for compliance and auditing purposes.
- Facilitates the generation of detailed reports for internal and external audits.
Scalability:
- Scales easily with the organization's growth, accommodating increasing leases without a proportional increase in manual workload.
- Adapts to changes in lease portfolios, ensuring flexibility in managing diverse lease agreements.
Integration with Other Systems:
- Integrates with other financial and enterprise resource planning (ERP) systems for seamless data exchange and consistency across the organization.
- Enhances overall financial management by connecting lease data with broader financial processes.
Adoption of Technology Standards:
- Embracing lease accounting automation aligns organizations with evolving technological standards, ensuring they leverage the latest advancements in financial management.
Integration is important because it improves efficiency. When different systems or processes are integrated, they work together seamlessly, saving time and effort.
When is the right time to automate your lease accounting?
It is subjective, but we recommend automating when you have ten or more leases. Sure, using spreadsheets for 15 or even 20 leases is still possible; however, with ASC 842, maintaining your leases using spreadsheets will become increasingly challenging.
Lease Count Examples:
- One Lease: If you have one lease, it is possible and relatively easy to manage in a spreadsheet. However, it can be a pain when specific numbers change due to modifications and renewals. You must also keep referring back to ensure your journal entries are correct, but it's manageable.
- Five Leases: If you have five leases, it gets a lot more complicated with multiple tabs, formulas, and summarized disclosures. You can also manage them in a spreadsheet. However, you'll need to allocate the responsibility to an accountant who is well-versed in accounting principles to maintain the leases.
- Ten Leases: You're in software territory if you have ten leases. Sure, using spreadsheets for 10, 15, or even 20 leases is still possible, and indeed, many organizations still do this. However, with ASC 842's requirements around balance sheet recognition of an asset and liability, maintaining your leases using spreadsheets will become increasingly challenging.
To conclude, don't wait for the following to occur:
- When calculations are too complex: These complex calculations make it easy to make a mistake. Missing a plus sign in your formulas, incorrectly keying a few numbers, or missing a cell address in your disclosures, for example, can lead to material errors and much more time spent on the audit.
- When Excel is having issues with complexity
- When your auditors start having issues
Want to learn more? Download our presentation and lease accounting assets from Tablespoon and FinQuery.