Entities implementing the new accounting standard should consider how to sustain the updated process on an ongoing basis
The Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2016-02, Leases, on Feb. 25, 2016 (ASC 842). For any entity reporting under generally accepted accounting principles, the new accounting standard will increase transparency into previously off-balance-sheet leasing obligations. The primary change from current accounting is that lessees will be required to gross-up their balance sheets to recognize assets and liabilities for virtually all leases.
Entities are at different stages of the adoption process. Some are beginning the mobilization and scoping effort, while others have developed their target operating model and are implementing their software solution. Given the level of effort required to adopt and the fast-approaching effective dates below, it is imperative that organizations prioritize and allocate the necessary resources to the implementation effort.
To address stakeholder concerns regarding the transition requirements initially included in ASC 842, the FASB submitted a proposal to allow entities the option to apply the new accounting standard at their respective adoption date without adjusting comparative periods. Comments on the proposed update were due on Feb. 5, 2018.
Entities adopting ASC 842 should plan ahead to ensure a smooth, timely transition. While entities must implement the new accounting standard as of the effective date, they also should consider how to sustain the updated process on an ongoing basis. In adopting the standard, Navigant has generally noted the following challenges:
Resources. Limited staff, experience, and time are all factors that can pose a challenge for an entity. Resources will need to have knowledge of the business to gather the necessary information. Additionally, while an entity’s accounting department will be involved along with others, they are likely working to implement other accounting standards (revenue recognition, current expected credit loss) or valuing their deferred tax assets and have limited availability.
Population. Identifying the universe of leases, particularly embedded leases, can be a daunting task, as many entities do not currently have a complete list of the population across their entire organization. While entities generally have a good grasp on their real estate leases, they may need to survey various departments, analyze accounts payable, review profit and loss journal entries, or run data analytics to identify the complete population.
Data. While some entities have been able to leverage data within existing systems, others have had to compile and examine hundreds or even thousands of lease agreements across business units, subsidiaries, and geographies. Locating leases, either domestically or internationally, can be an arduous undertaking. Each of the leases may also be in different formats, languages, and conditions. Additionally, entities may have to go “off-lease” to obtain certain data elements that were not previously documented within the lease agreement. After compiling its lease inventory, entities have to determine the key data elements necessary to account for and report its leases and extract them.
Systems. Whether modifying an existing enterprise resource planning system, implementing a new lease management system, or developing an in-house solution, the selection and implementation process can be difficult and time-consuming. Entities are realizing that it takes longer than initially anticipated to select and implement a system. This is a critical component of the implementation process as it is preferred that leases are centralized and digitized to accurately account for and report them as of the adoption date, as well as on a recurring basis.
Other. Considering the substantial gross-ups of long-term assets and liabilities, there will likely be impacts to many financial metrics that stakeholders use to evaluate performance. Entities are preparing stakeholders for this significant change through communication and early disclosures. Additionally, the new liabilities on entity balance sheets will have an effect on debt covenants, which entities are reviewing and evaluating.
Navigant recommends that entities consider the following areas when adopting the new accounting standard:
Develop Implementation Plan. All parts of the entity should work in a cohesive manner to ensure that it is able to effectively transition to the new accounting standard. Entities should coordinate across all business lines that interact with the lease process to involve all relevant stakeholders (e.g., procurement, treasury, A/P, real estate, corporate IT, operations and logistics, accounting, and legal). They should create a plan or timeline with milestones and accountabilities. Additionally, they should develop a dashboard or scorecard to keep key stakeholders and team members apprised of implementation requirements/steps and statuses and to help identify bottlenecks or roadblocks.
Develop Accounting Policy and Procedures. Entities will need to draft accounting policy and procedures for the organization to comply with ASC 842. Entities will need to re-examine lease inventories across different business units, subsidiaries, and geographies, and determine the appropriate accounting treatment for each lease. Among other items, they should address how the entity will handle key accounting policy decisions such as materiality thresholds (scope), portfolio approach (aggregating similar leases, such as IT equipment, that may be provided to every employee), separating lease and nonlease components, lease amendments/addendums, embedded leases, related-party leases, lease renewals, discount rates, variable payments, and below-market rent leases.
Develop and Implement Necessary Processes, Systems, and Controls. Entitles should develop, implement, and/or update the necessary processes, systems, and controls to ensure proper accounting treatment of leases and reliable, complete, and timely financial reporting. The collection of leases and selection of an appropriate system that meets the business needs of the organization is integral to the success of the transition. Organizations should identify the appropriate system for them by evaluating items such as classification, journal entry extraction, general ledger upload, and reporting capabilities. Adding controls such as types of leases that may require review should be considered. Compiling a complete list of controls during the implementation process will also help entities be prepared for any future Sarbanes-Oxley Act (SOX) audits.
Training. Entities should hold ASC 842 workshops to train its employees on the new accounting standard. As the standard may lead to the re-evaluation of the entity’s business rationale for leasing, it is imperative that affected employees understand the definition of a lease and can identify one during business activities.