The focus on lease accounting readiness since the Financial Accounting Standards Board released the new standard in early 2016 has been primarily on public company implementations. With more than three-quarters of public companies already past the effective date, the spotlight is now on private companies as they quickly approach their end-of-year deadlines.
The new standard is one of the biggest accounting changes ever as some $3 trillion worth of assets transfer onto corporate balance sheets in the coming years.It’s not often that new line items are added to the balance sheet and, as a result, the new right-of-use assets and liabilities will be heavily scrutinized by equity and debt holders, external auditors and independent board members following adoption.
A recent study,
Public company lessons
Throughout 2019 and 2020, as private companies go through their implementation projects, they will have the benefit of being able to consult public SEC filings for their peer group to see real-world examples of quantitative and qualitative disclosures. Most 2018 filings from public companies included comments on the materiality of impacts to the balance sheet, income statement and cash flow statements in SAB 74 disclosures and the Management Discussion & Analysis of annual reports. Throughout 2019, a rich set of examples will be published in 10-Qs and 10-Ks for private companies to study. SEC comment letters and additional revisions to ASC 842 by the FASB will also provide clarity on how to apply the principles in the standard.
Some companies will likely begin to take proactive measures to simplify their lease accounting. Some will rewrite policies to de-scope entire asset categories or individual leases whose dollar values fall below certain thresholds. Others will begin to renegotiate leasing contracts with vendors upon renewal to eliminate certain pricing structures and terms that drive complexity in the accounting. A handful of pioneers have standardized their leasing contracts with a consistent set of terms for all commercial banks, vendor captives and independent equipment finance vendors. Contract standardization reduces the time to process a lease and lowers outside counsel fees. It can also reduce accounting complexity by ensuring that the pricing structures and terms that drive complexity are eliminated across the portfolio.
Investing in process
Collecting data, implementing systems and modifying business processes will be the largest work efforts required prior to day one. However, many additional activities need to be completed as well, which many public companies underestimated. Most of these fall into the “last mile” of the project in the final 90 days before transition. Testing the accuracy of the accounting is proving to be a formidable challenge for many large public companies. There are over 100 billion combinations of use cases that can exist under ASC 842 when considering the different payment structures and events that can occur throughout the leasing lifecycle. In addition to developing a strong test plan, project teams will need to train end-users and communicate policy changes throughout the organization. Perhaps most importantly, companies will need to staff a team of lease accountants to perform ongoing analysis of changes to the portfolio. Some may need to build centers of excellence specifically focused on leasing.
Year one readiness
Although most private companies currently are focused on getting ready for the deadline, the project is not over once the new standard is adopted. In fact, many have described the implementation process as “a race to the starting line.” Public companies in the first quarter of adoption are struggling with issues such as proving the accuracy and completeness of their lease population. Perhaps the greatest challenge, however, is the need to track changes to the lease portfolio. A company with 300 leases will have to track an average of 230 events in a single year as assets come off lease, new leases are signed, and changes occur throughout the term. Real estate leases have frequent rent changes as well as expansion clauses, tenant improvement allowances and early renewal options that can be executed at various points in a 10-year lease. Equipment assets under lease can be lost, stolen, damaged, purchased, returned, renewed or upgraded during the relatively short term of a three-year lease. Tracking these activities with spreadsheets and emails will prove challenging even to the most organized of accountants.
Road ahead
As private companies race to meet the implementation deadline, they should be mindful not just of day one considerations, but also of the need to set up scalable business processes for day two and beyond. Perhaps the biggest challenge for private companies will be tracking the ongoing changes to the lease portfolio. Each month new leases are being signed, expiring leases are being terminated or renewed, and existing leases are being modified. These changes will need to be promptly communicated to the accounting team before month-end close to ensure accurate calculations.
