Lease Accounting Changes
Lease Accounting Changes
By now, the joint project of FASB and IASB to converge United States and IAS-17 is inevitable. The objectives of the proposed standard to include more transparency, eliminate off-balance-sheet obligations, and provide a faithful representation of leasing transactions are clear. However, the proposed changes will affect the value of the operating leases as they become capitalized and added to a company's balance sheet both as an asset and a corresponding liability. The current rent payments will be replaced with implied interest and amortization expenses on the income statements. Therefore, metrics like EBITDA, net income, and cash flows from operations will be dramatically affected. This, in turn, might shift the dynamic between lessee and lessor as lessees might opt for shorter lease terms and purchase assets instead.
Here are the Two Major System Changes We Expect from the Lessor Side:Payment and Residual expected to be reported separately - Traditional leasing software has payment amortization and residual amortization combined into one calculation as defined by current accounting standard. The new accounting change will require a separate payment amortization schedule and a residual accretion schedule for accounting and reporting purposes. This means significant customizations required to break out those fields and calculations. Fortunately, NetSol LeasePak solution is built with the foresight of choosing the combined option or the independent option. For us, it's a matter of setting the "Accrete Residual" field to "Y" and the calculation will be generated separately.
Using an example of a lessor manufactures, a machine for $7,500 with a fair value of $10,000 and enters into a three-year lease with an annual payment of $2,400 paid at the end of the year, residual asset at the end of the lease term at $4,770, and 7.87% IRR.
New fields required - Because of the changes, new fields will be required to be displayed. Some of them include:
- Cost of Asset
- Present Value of Lease Payments
- Carrying Value of Asset [(Cost of Asset x PV of Lease Payments) / Asset Fair Value]
- Profit at Commencement [PV of Lease Payments - Carrying Value of Asset]
- Gross Residual (PV of Estimated Future Value)
- Net Residual [(Cost of Asset x Gross Residual) / Asset Fair Value]
- Deferred Profit [Gross Residual - Residual Asset]
These are some system changes that will impact existing leases and any new lease when the accounting changes become ratified. At NetSol, we work closely with our customers regularly in anticipation to these changes. We understand the business impact and we are here to help minimize the costs and provide a smooth transition.
Written by Farooq Ghauri, Chief Operating Officer NTA
Back to Articles