New Lease Accounting Rule: Emerging Best Practices(July 2019)
the new leasing standard at the top of this year,
best practices are emerging
that both public and private companies
can leverage immediately.
These best practices revolve around
efficient identification of all of a company’s leases,
finding the right calculation platform and
establishing on-going processes.
With public companies having started to implement the new leasing standard at the top of this year and the deadline for private companies’ implementation now a brief six months away, I’m beginning to think of 2019 as the Year of Great Adapting – for businesses, for audit firms and for independent consultants like us. It’s an opportunity to take what we all learned from public companies’ initial implementation and apply the lessons learned so that public companies continue getting better at managing the myriad requirements of the new standard and private companies benefit from the accumulated experience.
As we at BGA continue to expand the number of companies we’re helping to implement the new standard, a sharp picture is emerging of what’s necessary for companies to get and stay compliant. Some of the emerging issues are what we expected; others are more surprising. And it goes without saying that the more leases or contracts a company has in place, the greater the impact on the company, its employees, and its current and future results.
For this newsletter, I’ve asked Will Richards, one of BGA’s lease accounting experts, to discuss the top three implementation issues that he’s consistently observing in engagements and the best practices that are emerging around them. At the end of this newsletter, I’ll talk about a new turnkey solution BGA has launched – LeaseDashBoard℠ – for businesses that need assistance determining lease calculations under ASC 842 and IFRS 16 in order to convert data into audit-ready financial statements.
Perspective from Will Richards, CPA
When the new rule was issued, compliance seemed a pretty simple endeavor – at least on the surface. All leases – financing and operating – had to be recorded on the balance sheet. But, once businesses, consultants and auditors got into the details, there turned out to be more permutations than any of us imagined. Leases were not just official corporate documents. And answers were not what we anticipated. Even companies with just a handful of leases found they needed to perform lots of calculations that could change financial results significantly. Since everyone was in learning mode, most days seemed like surfing in the big waves before any of us knew how to surf.
After leading several BGA lease accounting engagements in 2019, here are the top three challenges that I see emerging for public and private companies.
- Full and thorough identification of leases
Companies think they know their lease population; most are wrong. In our engagements, we’ve found that going to the company’s official lease repository – usually the accounting department – is often just the start, and the easiest part, of the search to uncover the full universe of a company’s leases. That’s because in many companies, individual departments have the authority to enter into various kinds of arrangements to get the department’s job done. These arrangements often reside under a number of names other than lease – subcontractor agreements, equipment rentals, warehousing contracts, transportation and delivery services, relocation packages (including apartment rentals and sublets), etc. In the past, departments would most likely report the costs associated with these arrangements as expenses within their departmental budgets without any reference to the signed documents or the dynamic terms and conditions within those documents. Under the new rule, these signed documents may qualify as leases and must now be recorded on the balance sheet. Taken together, these embedded leases can significantly outnumber the company’s officially recognized and acknowledged leases – often surprising accounting department management. And when all the hundreds of discrete terms and conditions are analyzed and entered, these embedded leases have the potential to significantly affect results.
A few things are clear from this scenario. Identifying all of a company’s leases is an enterprisewide endeavor – far beyond accounting into facilities, operations, IT, HR, marketing, services, etc. Accounting departments, in addition to not having knowledge of these documents in the first place, don’t have the authority to issue companywide mandates. The best practice that’s emerging here is the necessity for senior management – the entire C-suite of executives – to embrace and communicate the need for all departments to cooperate and collaborate in ferreting out the necessary information. In other words, companywide buy-in is essential.
Once the parameters of cross-functional cooperation have been set, there’s the question of resources. Finding embedded leases is time-consuming. Analyzing leases for material issues requires expertise. Accounting departments have the expertise but most likely not the resources for such a labor-intensive undertaking. Supplementing internal staff with experienced professionals has become another best practice.
- Finding the Right Calculation Platform
The possible explosion of a company’s lease population will affect how the accounting department calculates and prepares entries. For smaller companies with 15 or fewer leases, automation via Excel is an option. But, for companies with more than 20 leases, Excel starts to break down. Where to turn?
Because there are so many different kinds of leases and embedded leases needing analyzing, there’s no one software silver bullet that can handle the myriad different requirements to execute accurate calculations (e.g., equipment leases playing out differently than real estate leases, dynamic factors such as renewal terms and conditions, changing interest rates, right-to-use asset agreements, etc.). As a result of such competing requirements, any available software requires some manipulation – often leaving users unsure of the calculation. And while tools can handle about 95 percent of requirements, an additional challenge is entering the right data in the right place (e.g., when does a lease start?). Finally, irrespective of the software options, many companies simply don’t want to invest in additional software.
Again, a couple of things are crystal clear. Companies are responsible to arrive at accurate calculations; however, because companies are doing it for the first time, they can chase their tails forever if they don’t have a process for arriving at accurate calculations and preparing journal entries. The emerging practice here is independent consultants to fill the void. Some are offering straight technology solutions for purchase. Others, like Blythe Global Advisors, are offering turnkey solutions combining technology with expert services to arrive at accurate calculations of each lease – overt and embedded, expired, modified, etc. Marc will talk about BGA’s LeaseDashBoard solution later in this newsletter.
- Establishing On-Going Processes
Once legacy leases have been reviewed, analyzed, recorded and accurately calculated, the focus needs to turn to internal controls to establish processes for continual maintenance of both legacy and new leases. For legacy leases, this means the on-going recording of dynamic data to arrive at accurate calculations over the life of the lease. For new leases, this means the immediate recording and extraction of relevant data into the central system to complete the full picture of every lease’s impact on the company’s bottom line. Finally, there are the people holding all these processes and systems together. Legal, accounting, finance and the respective departments must enter into new and on-going coordination and collaboration to assure all material information is shared and known.
- Assisted a $450 million private equity-backed retail company evaluate more than 300 leases representing potentially $100 million for proper accounting treatment and classification.
- Helped a venture capital-backed company evaluate and structure $40 million in lease commitments in connection with current lease accounting guidance and ASC 842.
- Assisting retail, technology and health science companies evaluate the impact of ASC 842 on existing lease portfolios.
- Worked with several equipment and real estate lessors to educate executives and company representatives on ASC 842, including assisting in the evaluation of software to streamline their customers’ implementation of the new rule.
Final Thoughts From Marc
Will’s remarks hark back to a theme I’ve repeated endlessly since I started these newsletters. Whether the issue is lease accounting, revenue recognition, an IPO or M&A, an ERP implementation – whatever – full, clear and transparent communication from top management to key constituencies is essential to success. Employees need to understand why new processes, relationships and collaboration are essential to achieving goals. Investors, analysts, bankers and/or prospective buyers need to understand if or how a new rule or strategy or transaction will affect results before such results are announced. Both groups need to know that executive management is fully engaged in all initiatives.
The challenges Will outlined are steep but not insurmountable. Uncovering all leases and then analyzing and determining calculations under the new standard is complicated. Regulatory guidelines prohibit auditors from providing many of the services clients might be expecting them to supply – calculations, expanded guidance, MD&A discussions, footnotes, etc. As independent consultants, we at Blythe Global Advisors have developed LeaseDashBoard, a one-stop, turnkey service to help businesses determine calculations under ASC 842 and IFRS 16 as a basis for converting the data into audit-ready financial statements. As part of our end-to-end lease accounting services, LeaseDashBoard helps strengthen compliance, reduce risk, decrease organizational complexity, facilitate informed decisions, increase speed and efficiency, and lower the total cost of compliance. It requires no purchase of software and is delivered as an easy-to-use tool prepared by accountants and former accounting and finance professionals for accountants and current accounting and finance professionals. You can learn all about LeaseDashBoard and how to open a conversation with us here.
If you would like to discuss anything in this or any of my newsletters, please contact me. I’d be delighted to talk with you. We’d be honored to work with you.
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