Lease accounting, once considered a straightforward process, has undergone significant changes with the introduction of new standards like ASC 842 (in the U.S.) and IFRS 16 (internationally). These standards aim to increase transparency by requiring businesses to recognize almost all leases on their balance sheets. For small businesses, understanding and implementing these changes can seem daunting, but it doesn’t have to be. With the right approach, lease accounting can become a manageable and even insightful part of your financial operations.

Understanding Lease Accounting Basics

A lease is essentially a contract granting the right to use an asset—like office space, equipment or vehicles—for a specified period in exchange for payment. Under the new standards, businesses must classify leases as either finance leases (similar to ownership) or operating leases (for temporary use). Regardless of classification, most leases now require recognition of both a lease liability (the obligation to make payments) and a right-of-use (ROU) asset (the benefit of using the asset).

For small businesses, this shift means that lease obligations, which were previously off-balance-sheet for operating leases, now directly affect financial statements.

Why It Matters for Small Businesses

The new lease accounting rules enhance transparency but also impact key financial metrics like debt-to-equity ratios and EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). Lenders, investors and stakeholders often assess a company’s financial health using these metrics, so accurate lease accounting is essential.

Moreover, many small businesses lease essential assets rather than purchasing them outright. Understanding how to account for these leases ensures compliance and provides a clearer picture of financial obligations.

Steps to Simplify Lease Accounting

Identify and Categorize Leases
Start by compiling all your lease agreements. This includes not only formal leases like office rentals but also less obvious contracts, such as equipment leases or embedded leases in service agreements. Categorize these leases as operating or finance leases based on the criteria set by your applicable accounting standard.

Calculate Lease Components
For each lease, determine the following:

Lease Liability: The present value of future lease payments.
ROU Asset: The value of the lease liability, adjusted for initial direct costs and any lease incentives.
Use tools like spreadsheets or lease accounting software to handle calculations efficiently, especially if you have multiple leases.

Recognize on the Balance Sheet
Record the lease liability and ROU asset on your balance sheet. Regularly update these amounts to reflect changes in lease terms or payments.

Track and Report
For ongoing compliance, track lease payments and remeasure liabilities if lease terms change. Ensure that you include appropriate disclosures in your financial statements to provide transparency.

Leverage Technology

Investing in lease accounting software, like the one provided by Yardi Corom, can significantly simplify the process. Many tools are designed specifically for small businesses, offering automated calculations, compliance checks and reporting capabilities. These solutions save time and reduce the risk of errors compared to manual processes.

Seek Professional Help When Needed

If lease accounting feels overwhelming, consider consulting with an accountant or financial advisor familiar with the new standards. Their expertise can help ensure compliance and provide clarity, particularly during the initial transition.

Conclusion

Lease accounting may seem complex at first glance, but with the right approach, small businesses can handle it effectively. By understanding the basics, categorizing leases correctly, leveraging technology and seeking professional advice when necessary, small businesses can stay compliant while gaining valuable insights into their financial commitments. Simplifying lease accounting not only ensures peace of mind but also positions your business for long-term success in a transparent financial landscape.

Yardi Corom is a comprehensive and user-friendly accounting, lease and workplace management solution for CRE tenants. Our cloud-based software solution increases efficiency and accuracy across your entire lease portfolio: manage leases and subleases, track key lease data, centralize transactions and become FASB/GASB/IFRS compliant. To learn more, you can visit our website or schedule a meeting with our team.