The Financial Accounting Standards Board’s issuance yesterday of its updated lease accounting standard ushers in a new era in which companies will recognize most leases on their balance sheets. This change will increase reported assets and liabilities for companies across all sectors – in some cases very significantly, with trillions of dollars of lease obligations expected to move onto balance sheets by January 2019.
Well before the new standard becomes effective, companies will need to assess how widespread its effects will be so they can plan for needed business and process changes. To successfully implement the new lease accounting rules, CFOs should focus on five key action items from the outset:
Lease agreements often involve not only real estate, but also equipment, automobiles, and other industry-specific leased items. Understanding the impact of their terms and conditions will be critical to successfully navigating the new requirements and their resulting financial reporting and business impacts. This may require a substantial effort to identify all of the organization’s leases and accumulate the lease data necessary to apply the new guidance.
The new accounting rules may affect how companies approach new leases, and may prompt them to renegotiate some existing leases. Executives may want to more critically analyze lease-versus-buy decisions, and perhaps negotiate different terms and conditions in lease agreements to manage the impact of the new rules. Finance chiefs will need to think about how the new rules will affect shareholder’s equity, leverage ratios, and capital requirements. Further, CFOs will need to consider whether the changes in lease accounting affect any of their companies’ other business arrangements – employee compensation or financing arrangements, for instance.
2.Ensure executive sponsorship of the adoption process and set up a team approach.
Implementing the new leasing rules is more than a compliance exercise. Ensuring buy-in from key executives is critical for strategic and effective adoption. But compliance will also be challenging. For example, the new rules require some lessees to change the reported balance sheet and income statement amounts for leases during the lease term, even if the lease contracts have not been changed. Given the widespread, and potentially material, effect these requirements will have on a company’s financials, companies will need to set up processes and controls to address the new risk points. This effort will likely need cross-functional coordination to ensure timely identification of circumstances that affect lease accounting.
3.Define a roadmap early on to streamline adoption and final implementation.
Besides the accounting changes, the new standard requires companies to disclose more qualitative and quantitative information about their leases. Companies will need to develop a detailed implementation plan tailored to their industries. The plan should include activities required by each business group, a schedule for completing key activities, and the recording of important milestones. Forming a dedicated project management team will help companies identify key objectives, set a timeline, and create governance protocols.
CFOs should think about whether their companies have appropriate systems, processes, and internal controls to capture completely and accurately the lease data needed to comply with the new rules, including the expanded disclosure requirements. They should investigate technology solutions that can provide support for the transition and the future. This process is bigger than simply implementing new systems– there will also be a need for new training. Business units likely will need to interact and communicate with the finance function in new ways.
4.Prepare to communicate more information about leasing transactions to investors.
The disclosure objective of the new standard is to provide financial statement users with enough information to assess the amount, timing, and uncertainty of cash flows arising from leases. Key balance sheet measures and ratios may change, affecting analyst expectations and compliance with contractual covenants.
Analysts and investors will take a close interest, focusing on valuation and the effect on financial results and leverage ratios. Currently, many analysts adjust financial statements for off-balance-sheet lease obligations. After the new requirements are applied, analysts will be able to see a company’s own assessment of its lease liabilities.
But since all analysts don’t evaluate leases in the same way or for the same reasons, they may still make adjustments to corporate financials after the new standard becomes effective. CFOs should be prepared for the likelihood that analysts may ask for new information or that new inquiries will arise.
5.Decide whether to adopt the revenue recognition and leasing standards in sequence or at the same time.
Since both standards require a considerable amount of time to implement and synergies may exist if they are adopted concurrently, companies may want to implement both at the same time through a single adoption plan. But in companies where staffing is an issue, they can implement the revenue recognition standard before the leasing standard.
By understanding how the lease accounting changes affect their businesses beyond accounting, CFOs can use the implementation process to analyze and improve existing business models and processes to create value beyond the compliance exercise.
Kimber Bascom is KPMG LLP’s global leasing standards leader and the partner in charge of the accounting group of the firm’s audit department of professional practice. Dean Bell is KPMG LLP’s lead partner for new leases standard implementation.