Many businesses will face great hurdles in implementing the new lease accounting standards, FASB’s ASC 842 and IASB’s IFRS 16. That is a stark reality, as the rules will be effective for fiscal years beginning after Dec. 15, 2018 for public companies and Dec. 15, 2019, for nonpublic companies.
The standards will fundamentally alter accounting by requiring that both operating and finance leases be recognized on a company’s balance sheet. The changes will impact the operations of almost every organization, regardless of size, industry, or geography.
Under the new guidance, an arrangement contains a lease only when the arrangement conveys the right to control the use of an identified asset. That’s a change from legacy guidance, under which an arrangement can contain a lease even without such a right if the customer takes substantially all of the output from the lease over the term of the arrangement.
In addition to the lack of bright lines used under legacy guidance, FASB added a new criterion that focuses on assets that have a specialized nature with no alternative use at the expiration of a lease. That’s important, as it may modify the lease’s legacy classification.
Companies that we at Pine Hill Group have spoken with say they are anxious to get started but are constrained by inadequate resources, lack of in-house expertise, and finalizing compliance with the new revenue recognition standard. As the clock continues to tick, many are overwhelmed by the magnitude of the project and are unsure how to chart a path toward compliance. [Editor’s note: the authors’ organization, Pine Hill Group, provides accounting compliance services.]
Within just the next few months, companies will need to adopt modern, centralized processes for collecting, testing, and recording leases for real estate and property, plant, and equipment assets.
That could be daunting, given that the number and locations of leases are often mysteries. Discovering and collecting such data may be a challenge because leases exist in an array of formats across a sweeping landscape of back-office systems and data types.
However, preparing for the new standard will ultimately help businesses streamline lease management by delivering a methodology to improve lease accounting technologies, processes, and professional skills.
The ability to better track and manage leases can sharpen visibility into lease spending and enable businesses to negotiate new leases using the power of data. What’s more, updated technology solutions can increase the accuracy of accounting, streamline audits, and save time and costs in preparing financial reports, footnotes, and regulatory responses.
Overall, adding substantially all leases to balance sheets will give corporate executives, shareholders, and investors more accurate financial information about the company. It will also create consistency and comparability for financial statements and help deliver additional insights into the true value of the business.
Each organization will need to fully understand how the accounting standards update will impact the business, develop a phased implementation methodology, and identify the right team to effect the changes.
The good news? It’s a highly manageable initiative. Following are four steps for successful implementation.
First, you’ll need to identify a lease accounting project leader with deep technical understanding of the new standard as well as an encyclopedic knowledge of the company’s lease data.
Another requirement is the ability to gauge potential impacts to balance sheet ratios and communicate those outcomes to stakeholders. We believe the person best suited to lead the project is typically found in the controller’s office.
We also recommend appointing a steering committee that disseminates information from the project team across the organization. Candidates should be involved in some part of the end-to-end lease process, from execution through the financial reporting. That can include staff from accounting, finance, treasury, operations, legal, and tax, among others.
Among both public and private companies, it’s very likely that there will be overlaps in professional skills between the new revenue recognition and upcoming lease accounting initiatives. Private companies may want to consider combining the two implementation projects to achieve savings in time, costs, and resources.
To compile a list of all leases, project leaders should first identify all departments that have or may be aware of leased assets. Only then can they assemble the comprehensive list of all leases — and the specific data points — that the new standard requires.
It can be a tedious process, and it may require digging deep into financial records for rent expenses to find simple leases that were not formally traced in contracts previously.
Collected lease data should include the types and numbers of property, plant, and equipment leases, availability of digital lease data, and gaps in lease data.
There may be dozens of discrete pieces of data requiring two to four hours of review. In our experience, businesses often overlook embedded leases, which may be included as part of a larger service agreement. Embedded leases are often complex arrangements that require closer scrutiny and advanced technical accounting skills.
The project leader should work with stakeholders to establish a threshold and a policy for leased assets and to document the reasoning behind these decisions. It’s a good idea to involve internal auditors early in the process to obtain buy-in and to ensure decisions are coordinated.
Next, the project leader should select a cross-functional team to coordinate the implementation. It’s critical that the team includes technical accounting experts with deep experience in financial reporting. Then you can mix it up a bit: Members from disparate business units can contribute broad operational knowledge to the project.
After the lease data is collected, the project leader should set accounting policies to determine which leases require adjustment under the new standard. This documentation must be meticulous and comprehensive, with precise guidance on accounting policies, expedients elected, and overall compliance with U.S. GAAP or IFRS.
Using internal whitepapers or memos to document policy decisions is a sound practice, one that also can assist internal auditors in their audit process. Changes regarding materiality could warrant discussions with a lease accounting expert or an auditor.
During the implementation phase, companies must calculate and process new lease entries for day-one entry into the balance sheet. As the calculations are entered, continue the ongoing dialogue with your auditor and provide training for the project team on the new lease accounting policies and considerations.
We suggest that the training consist of mock exercises, with examples including finance, operating, and embedded leases, to ensure proper implementation.
Companies also will likely want to review lease technology to help automate lease-data entries on a go-forward basis.
Ongoing: Sustainably Managing Lease Data
Implementation of the new lease standard doesn’t conclude at the compliance deadline. That’s because compliance with the standard is not a one-time event. Rather, it’s an ongoing discipline that must be managed and maintained as new leases and accounting changes are added.
What’s needed is a centralized data-management system that sustainably manages digital leases and their impact on balance sheets. Think of it as an opportunity: ASC 842 presents a case to deploy new lease accounting software that automates the standard’s data storage, classification, calculation, and reporting requirements. That will save you money in the end.
While some businesses still manually manage leasing data on spreadsheets, companies are increasingly storing such data in digital formats.
Trouble is, this information is often incomplete and resides in disparate, unconnected systems, making the collection and integration of data a resource-intensive effort. Assessing and implementing new IT components — or developing new functionality within existing systems — often benefits from the expertise of an agnostic third party.
Businesses will also need to monitor and respond to comments on financial statements from regulatory bodies like FASB and the SEC. Some may also need external assistance to address comments and understand the business implications of new exposure drafts as they are released.
William Andreoni is a senior director at Pine Hill Group, a finance and accounting consultancy and a provider of M&A advisory services.