Growth Companies

Ready for the New Lease Accounting Standard?

There are 10 critical issues that U.S. companies are struggling with as they prepare for ASC 842.
Deloitte & Touche, Sean Torr, Jeanne McGovern, and Deloitte & ToucheOctober 9, 2018

The new standard for lease accounting (Accounting Standards Codification 842) is intended to provide investors and other stakeholders with a more complete and transparent view of a US company’s financial position with respect to leasing activities.

Its main objective is to address concerns about companies using operating leases as a form of off-balance-sheet financing. The new standard ends that problem by requiring nearly all operating leases lasting more than one year to be accounted for on a lessee’s balance sheet.

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The standard’s effective date for public companies is fast approaching — January 1, 2019. Privately held institutions have until the following year (January 1, 2020).

For calendar year-end public companies working to implement the lease accounting standard by this January, achieving compliance can be a complex and time-consuming process that may require major changes to business processes and internal controls related to leases. Depending on the nature and complexity of a lease agreement, more than 100 data elements may need to be captured — some of which are not contained within the lease contract.

Here are 10 critical matters that U.S. public and private companies will need to address before the new lease accounting standard goes into effect.

1. Pre-adoption disclosures. With the transition date fast approaching, public and private companies should consider acknowledging their planned adoption date of the standard in pre-adoption financial statements. In addition, entities should consider disclosing the potential impacts financial statement users should expect to see in their post-adoption financial statements.

The Securities and Exchange Commission has specifically stated it is expecting pre-adoption disclosures by U.S. public companies to be robust. This includes not only qualitative disclosures about implementation, planning, and progress, but also quantitative disclosures estimating the impact on a company’s financial statements. According to a recent internal Deloitte analysis of Fortune 1000 companies, more than 90% had yet to provide quantitative disclosures as of their first-quarter reports.

Jeanne McGovern

2. Incremental borrowing rates. ASC 842 requires companies to calculate the present value of future lease payments using an appropriate discount rate. For most lessees, this will involve developing incremental borrowing rates (IBR) for borrowings secured by collateral and with varying durations. Many companies are finding this to be a challenge, as the IBR for a lease can vary based on factors such as lease term, payment structure, the currency of the lease payments, and the lessee’s credit risk. Factoring in the impact of collateral can prove to be particularly difficult for companies with strong credit ratings as they often do not have to provide collateral when borrowing money. Also, IBRs change over time, so as companies enter new lease agreements, this will be an ongoing challenge that requires a robust and repeatable process.

3. Accounting and business process controls. The new standard will require a variety of new or revised accounting and business process controls, all of which need to be rigorously designed and documented to ensure a high level of quality and accuracy. In the scramble to meet the initial deadline, many companies have their hands full trying to get the numbers right; however, they will need to also support their reporting with robust processes and controls.

4. Information technology controls. Similarly, as with all accounting-related solutions, companies must ensure the technology platforms that support lease accounting activities are “fit for purpose.” In some cases, these platforms are owned and operated by third-party vendors. That may result in the need for a system and organization controls (SOC) report from an independent auditor. The report confirms that the vendor has adequate processes and controls in place for operations, system updates, and other relevant information-technology risks.

5. Abstraction of lease data. Extracting the required data from lease documents (e.g., lease term, payments, renewal, and termination options) is an essential step in the implementation process that, for some, can turn out to be more difficult and time-consuming than expected. Many companies were expecting cognitive technologies such as natural language processing and machine learning to make the job easy; however, in practice, such solutions may only provide automated abstraction for a portion of the data fields required to be abstracted. This data gathering effort may require significant manual effort to complete.

Sean Torr

6. Completeness of lease population. Another key challenge when gathering lease data is making sure all leases are identified and captured. In many cases, contracts that might not appear to be lease agreements have elements that must be accounted for as leases. Many companies are identifying the need to reevaluate their lease identification and tracking processes, particularly around embedded leases, to ensure that relevant leases are not overlooked. In addition, many companies will likely experience increased auditor scrutiny around the completeness of the lease population given the new requirement to recognize all leases on the balance sheet.

7. Footnote disclosures. ASC 842 includes extensive footnote disclosure requirements that will require deep technical analysis. Systems and processes should be designed to contemplate the disclosure-related data requirements. The expanded requirements of the new standard should be considered by companies in the near term so as not to become an afterthought when systems and processes are already implemented.

8. Contingency plans and temporary workarounds. With the compliance deadline looming, some companies are running out of time to implement robust lease administration solutions and might need to fall back on manual workarounds or other interim solutions. Whenever possible, however, they should try to minimize duplication and rework. Data portability should be a top priority since cleansing and extracting lease data from existing systems and documents is typically a time- and resource-intensive step. Companies should consider extracting the information necessary for their long-term solutions, not just what is needed for the immediate deadline.

9. Auditor communications. To avoid audit and compliance problems down the road, companies should consider proactively consulting with their auditors on challenging issues and keeping them up-to-date about the implementation and transition elections. It is especially important to discuss matters that involve significant uncertainty and judgment, such as the use of capitalization thresholds or the planned methods for determining IBRs.

10. Executive and board communications. Senior management and audit committee members will likely face questions about the company’s transition to the new leasing standard in the near future. In response, they need to be fully informed about the implementation status, steps to completion, open issues, and expected impact on the company’s financial statements.

Ready or Not?

For public companies, the transition to ASC 842 is just a few months away. Any organization not already well down the implementation path should consider immediately developing a clear strategy and aggressively allocating resources to get the job done. Ready or not, the time for compliance is almost here.

Jeanne McGovern, is audit & assurance partner, Deloitte & Touche. Sean Torr is a risk and financial advisory managing director at Deloitte & Touche.

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.

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