You Should Be Worried About Embedded Leases

The new lease accounting standards (FASB ASC 842 and IFRS 16) introduce rules as to how companies identify and measure the value of leases, and how they report them on corporate balance sheets. Nearly all off-balance sheet accounting for lessees will be eliminated. Companies will need to account for the present value of all lease liabilities on the balance sheet as debt, while also being able to account for a right-of-use asset.

The first step is to gather all contracts that now include a lease — anything that provides use of a physical asset and is valued at more than $5,000 per year. Don’t underestimate how much time it will take to find and review what could be millions of contracts. A common and hidden pitfall: tracking down leases hidden inside larger contracts — otherwise known as embedded leases. The new accounting standards expand the definition of a lease. The general rule is that an arrangement contains a lease if there is an explicitly or implicitly identified asset in the contract, and the customer controls its use. One effective way to uncover embedded lease language is to utilize artificial intelligence and technology-enabled processes to comb through contracts.

The new accounting standards are as much about legal as they are about accounting. Contracts intelligence is critical to compliance, as firms look to meet the new accounting standards and financial reporting deadlines, thus strengthening

legal’s position as a strategic player within the organization.