Many companies will face major obstacles in implementing the new lease accounting standards, ASC 842 of the FASB and IFRS 16 of the IASB. 15, 2019, for non-public companies.
The standards will fundamentally change accounting by requiring that both simple rental and finance rental be entered on the balance sheet of a company. The changes will impact the operations of almost any organization, regardless of size, industry or geography.
Under the new guidelines, an agreement contains a lease only when the agreement confers the right to control the use of an identified asset. This is a change from existing guidelines, under which an agreement can contain a lease even without such a right if the client takes substantially all of the production of the lease during the term of the agreement.
In addition to the lack of clear lines used under existing guidelines, the FASB has added a new criterion that focuses on assets of a specialized nature with no further use upon expiration of a lease. This is important because it can change the classification inherited from the lease.
The companies where we work Pine Hill Group spoke with say they are eager to get started but are constrained by inadequate resources, a lack of internal expertise and the finalization of compliance with the new revenue recognition standard. As the clock ticks, many are overwhelmed by the scale of the project and do not know how to chart the course to compliance. [Editor’s note: the authors’ organization, Pine Hill Group, provides accounting compliance services.]
In the coming months alone, businesses will need to adopt modern, centralized processes for collecting, testing and recording leases for real estate and fixed assets.
This could be intimidating, given that the number and location of leases are often a mystery. Discovering and collecting such data can be a challenge as leases exist in an array of formats across a vast landscape of back office systems and data types.
However, the preparation of the new standard will ultimately help companies to streamline lease management by providing a methodology to improve lease accounting technologies, processes and professional skills.
The ability to better track and manage leases can improve visibility of rental spending and enable businesses to negotiate new leases using the power of data. Additionally, updated technology solutions can increase accounting accuracy, streamline audits, and save time and costs when preparing financial reports, footnotes, and regulatory responses.
Overall, adding almost all leases to balance sheets will provide business executives, shareholders and investors with more accurate financial information about the company. It will also create consistency and comparability for the financial statements and help provide additional information about the true value of the business.
Each organization will need to fully understand the impact of updating accounting standards on the business, develop a phased implementation methodology, and identify the right team to make the changes.
The good news? It is a very manageable initiative. Here are four steps for a successful implementation.
First, you will need to identify a rental accounting project manager with a deep technical understanding of the new standard as well as encyclopedic knowledge of the company’s rental data.
Another requirement is the ability to assess potential impacts on balance sheet ratios and communicate these results to stakeholders. We believe that the best person to lead the project is usually in the controller’s office.
We also recommend appointing a steering committee that disseminates information from the project team throughout the organization. Applicants should be involved in part of the end-to-end rental process, from execution to financial reporting. This can include accounting, finance, treasury, operations, legal and tax staff, among others.
Among public and private companies, it is very likely that there will be overlaps in professional skills between the new revenue recognition and future lease accounting initiatives. Private companies may consider combining the two implementation projects to save time, costs and resources.
To compile a list of all leases, project managers must first identify all the departments that have or may be aware of the leased assets. Only then can they assemble the full list of all leases – and specific data points – required by the new standard.
This can be a tedious process, and it may be necessary to dig deep into the financial records of rent expenses to find simple leases that were not formally mapped out in contracts before.
Rental data collected should include types and numbers of property, plant and equipment leases, availability of digital rental data, and gaps in rental data.
There may be dozens of discrete data requiring two to four hours to review. In our experience, companies often overlook integrated leases, which can be included as part of a larger service contract. Integrated leases are often complex agreements that require further examination and advanced technical accounting skills.
Design / Evaluation
The project manager should work with stakeholders to establish a threshold and policy for leased assets and document the reasoning behind these decisions. It’s a good idea to involve internal auditors early in the process to gain buy-in and ensure decisions are coordinated.
Next, the project manager should select a cross-functional team to coordinate the implementation. It is essential that the team include technical accountants with extensive experience in financial reporting. Then you can mix things up a bit: Members of disparate business units can bring vast operational knowledge to the project.
Once rental data is collected, the project manager should define accounting policies to determine which rental contracts require adjustment under the new standard. This documentation must be meticulous and complete, with precise indications on accounting policies, chosen expedients and overall compliance with US GAAP or IFRS.
It is good practice to use white papers or internal memos to document policy decisions, which can also help internal auditors in their audit process. Changes in materiality may warrant discussions with a lease accountant or auditor.
During the implementation phase, companies must calculate and process new rental postings for a day one balance sheet entry. As calculations are entered, continue the ongoing dialogue with your auditor and provide training to the project team on the new lease accounting policies and considerations.
We suggest that the training consists of simulated exercises, with examples including finance, operating and integrated leases, to ensure proper implementation.
Businesses will also likely want to revisit rental technology to help automate rental data entry in the future.
In progress: Sustainably manage rental data
The implementation of the new lease standard does not end on the compliance deadline. This is because compliance with the standard is not a one-time event. Rather, it is an ongoing discipline that must be managed and maintained as new leases and accounting changes are added.
What is needed is a centralized data management system that sustainably manages digital leases and their impact on balance sheets. See this as an opportunity: ASC 842 presents a case for deploying new rental accounting software that automates the data storage, classification, calculation and reporting requirements of the standard. This will save you money in the end.
While some businesses still manually manage rental data on spreadsheets, more and more businesses are storing this data in digital formats.
The problem is that this information is often incomplete and resides in disparate and unconnected systems, making data collection and integration a resource-intensive endeavor. Evaluating and implementing new IT components – or developing new functionality within existing systems – often benefits from the expertise of an agnostic third party.
Companies will also need to monitor and respond to comments on financial statements from regulators like the FASB and the SEC. Some may also need external assistance in responding to comments and understanding the business implications of new exposure drafts as they are issued.
William Andreoni is a Senior Director at Pine Hill Group, a finance and accounting consultancy and provider of M&A advisory services.