The clock is ticking to fulfill the requirements of impending changes to lease accounting standards, which are creating a handful of organizational challenges for corporations. One of the more complicated of these challenges is finding lease rights and obligations from numerous (sometimes thousands) of lease agreements or other contracts across numerous locations and geographies. Many corporations are hampered by the uncertainty of where to start or how to tackle this issue and lack preparedness to make the transitions required by the new standards. Earlier this year Forbes reported a survey that found only 14% of companies considered themselves prepared for the new rules.
ASC 842 and IFRS 16, the two new standards that will impact lease accounting starting in January 2019, introduce new rules for how accountants recognize, measure, and disclose leases, both operating and financing, and how they report them on corporate balance sheets.
Though just over one year remains for corporations to implement the new processes and technology necessary to comply, a study by LeaseAccelerator found that only one-third of companies (250 accounting and finance leaders from U.S.-based public and private companies responded to the survey) have collected 25% or more of the data from lease contracts that they will need to update their accounting. More than half of companies in the survey stated that collecting the contract data presented a significant implementation challenge. The survey also noted that embedded leases within other contracts were creating additional challenges for about 40% of organizations.
To move toward compliance with the new guidelines and observe best practices, companies must pull key leasing information from contracts and record it in their accounting systems. Accounting departments, especially those within organizations that are frequent lessees, are facing some heavy lifting to collect required data from their lease agreements and leasing terms embedded in other contracts. Those are often documented in unidentified files and stored in disparate locations.
According to the International Accounting Standards Board, listed companies are estimated to have about $3.3 trillion of leasing commitments, and leasing obligations across individual corporations can range from a few million to tens of billions of dollars. Contracts and lease documents containing this liability information are typically decentralized and often exist as unstructured data, presenting not just a compliance issue but a big-data business problem.
Very few organizations, even those with robust real estate departments, have an organized, central repository for all lease-related contracts and associated data. Locating the full scope of leases spread across a corporation’s repositories and efficiently extracting the information needed to accurately report them will require a significant enterprise-wide effort.
The most successful contract intelligence practices combine advanced technologies with coordinated workflows of experienced contracts reviewers and accounting experts to inform compliance and implementation of new policies. Below are a few contract intelligence practices that can be utilized to confront challenges stemming from the new lease standards.
- Establish (the right) central repository. The first step in creating visibility into an organization’s lease documents is establishing a single location where they can be organized and viewed, comprehensively and in context. When designing or selecting a central repository, it is important to consider the activities required to generate truly useful contract intelligence: contract identification and scoping, clause and language insights, and analysis and related data outputs. Another key consideration is compatibility with any intended downstream accounting or lease management systems.
- Conduct tech-enabled collection. Typically, lease-related contracts live in a multitude of places and may not be properly identified, organized, or digitized. Casting a wide net to gather any potential lease documents (i.e., intentionally over-broad collection) will necessarily build a document set that is large and diverse but that can also be quickly defined and refined with the right artificial intelligence (AI) or machine-learning technology. This tech-first approach ensures both that relevant agreements are not overlooked and that over-investment in manual collection efforts are avoided wherever possible. Where that is not possible, a central team of collection professionals can complement technology and work across the various teams known to interact with leases and related contracts.
- Capture actionable lease data. Once leases are collected and accessible in an intelligent way, automation technologies and advanced data analytics can be applied to identify key information, such as counterparty information, lease term and renewal options, payment terms, and lease asset details. It is critical that analysis workflows are thoughtful and deployed to ensure that the best-suited team members are confirming and taking action on the appropriate captured data. Accounting subject matter expertise is required for more complex analysis, such as separating lease components, allocating consideration, and assessing lease modifications and purchase options. The best contract analysis workflows rely on technology to enable a flexible and variable team of resources. Those resources share the objective of producing reliable and consistent lease data for immediate action or for downstream implementation in lease accounting systems.
Contract intelligence paints a more complete picture of an organization’s compliance risks related to the new lease accounting standards and expedites the necessary policy implementation and book balancing. The processes also provide mechanisms that can support strategic decision-making across a corporation’s real estate portfolio and other scenarios that impact financial reporting.
For example, corporations have previously been penalized for using capital to purchase real estate, often making leasing the more favorable option. Lease reporting under ASC 842 and IFRS 16 will change how corporate indebtedness is interpreted, which may impact an organization’s compliance with covenants on its credit agreements. That introduces the need for accounting teams to more carefully evaluate their lease versus buy strategies and how their lease agreements impact overall debt.
Just like any area of business, leases bring risk and opportunity, but the new standards may impact how accounting teams evaluate those risks and opportunities. Knowing where and what the key information is can help facilitate implementation initiatives. Contract intelligence simplifies the process of garnering key insight from leases and supporting accounting teams in more effectively accessing the information they need for compliance with the new standards.
Ryan Drimalla, Esq., leads operations and solution development for FTI Technology’s contract intelligence service.