White Papers

Abstract

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The clock is ticking for public and private companies as the new lease accounting standards, namely IFRS 16 and ASC 842 by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) go into effect on January 1, 2019, for public companies, and one year later for private players. Primarily, the change mandates that all leases must be reflected on the companies’ balance sheets, with the overall aim being to increase transparency and streamline financial reporting. But while the new lease accounting standards were announced back in early 2016, many organizations are still far from prepared to handle the massive amount of additional recordkeeping and accounting work that their implementation entails. 75% of all organizations are still at the start of implementation and grappling with transition mechanics. In Deloitte’s recent flash survey, only 3% of organizations said that they are in the user acceptance testing phase and 9% indicated that their solution is deployed and they are in the refinement phase.

This paper explores the challenges in implementing the new lease accounting rules and what organizations should do to get started on their compliance journey.

Not an accounting headache alone

The impact of the new lease accounting standards will be felt way beyond organizations’ accounting departments and extend to virtually all systems and processes that deal with lease data. This will include procurement, operations, information systems and treasury functions. Furthermore, the impact will also extend across industries and not just corporate real estate as multi-year lease contracts are common in retail, manufacturing, healthcare, and other verticals.

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Planonsoftware, 75% of all organizations are still at the start of implementing new lease accounting rules, https://planonsoftware.com/us/whats-new/blog/75-of-all-organizations-are-still-at-the-start-of-implementing-new-lease-accounting-rules.html

Deloitte, April 2018 – Leasing Solutions, https://www2.deloitte.com/us/en/pages/risk/articles/center-for-controllership-flash-survey.html

Let’s take a look at the four key takeaways from the new lease accounting standards to really understand the breadth and depth of impact:

#1 Operating lease liability will not be a debt: Lessees must recognize all right-of-use (ROU) assets and lease liabilities on their balance sheets to show a clear distinction between owned assets (finance lease) and rented assets (operating lease).

#2 Income statements could see a dip: Adding liabilities and ROU assets to the balance sheets will alter the Return on Assets (ROA) and some companies could witness negative impacts on their income statements, especially if they allocated huge portions of internal costs to generating leases.

#3 The 12 month timeline exempts short-term leases: In a drastic change from the current Generally Accepted Accounting Principles (GAAP), all leases with a term of more than 12 months will need to be recognized on a lessee’s balance sheet. However, there’s some respite for short-term leases (less than 12 months) as these need not be reflected on the balance sheet.

#4 Operating leases will still be profitable: For operating leases, companies are required to show only the present value (PV) on their balance sheets, making these leases lowest in asset amounts and best performing in terms of ROA.

As the deadline for the wholesale change to the lease accounting process looms large, organizations are discovering that more than the accounting policy itself, it’s the systems, processes, and resources that constitute the key challenges in implementation.

People, Process, Technology: Three Key Roadblocks in the Way of Implementation

More than three-fourths of financial executives worldwide believe that data collection, systems and resources are the three biggest challenges in implementing the new lease accounting standards. Let’s deep dive into the specific issues here:

#2 Legacy data management solutions: Around two-third of companies globally leverage spreadsheets to record lease accounting data. However, come IFRS 16 and this simply won’t remain a viable option. That’s because calculations will become increasingly complex due to change in the financial lease character, disclosure of information will be more urgently required, and all calculations will have a direct impact on the balance sheet. Overall, this will require more active contract management that spreadsheets are simply not wired for. Organizations will need a custom-built software solution to adhere to the new compliance and reporting regulations.

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PwC, Lease Accounting Survey 2016, http://f.tlcollect.com/fr2/316/25730/Lease_Accounting_Survey_Summary_Report_June_2016.pdf

Deloitte, April 2018 – Leasing Solutions, https://www.pwc.com/us/en/press-releases/2017/pwc-and-cbre-survey-lease-accounting-standards.html

PwC, Impact of the New Leasing Standard, https://www.pwc.com/us/en/services/audit-assurance/accounting-advisory/leasing-change-impact-systems-data-processes.html

PwC’s recent survey revealed that 74% of companies are expecting systems changes with over 50% stating they will implement or develop a new solution. However, only 23% have already selected a leasing solution.

#3 Lack of lease monitoring: This steams from the above point – because companies often lack dedicated lease accounting systems, they fail to monitor leased assets effectively, leading to a cycle of inconsistencies in reporting and accounting. Inadvertently, such a situation also gives leeway to fraudsters, making lease data prone to thefts and attacks. Companies often lack dedicated resources as well as processes to monitor all leases. This is the reason why 47% of executives who have started implementation report that the efforts required are greater than expected.

Implemented right, the new standards could unlock opportunities galore

While the length and breadth of changes as well as their complexity is undoubtedly high, it would not be wrong to say that the new lease accounting standards present a blessing in disguise for most companies. That’s because beyond compliance, several potential benefits in the form of improved lease portfolio reporting and administration and end-to-end visibility into key leasing costs stand to be realized. Here are five steps organizations should take to get started on their implementation journey:

#1 Take stock: Before you get to the strategy table, complete a review and analysis of all existing leases and understand how they will be impacted by the new lease accounting standards. Also assess the impact of changes on the financial statements.

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PwC, Nearly a Quarter of Companies Slow to Start Adoption of Lease Accounting Standards, , https://www.pwc.com/us/en/press-releases/2017/pwc-and-cbre-survey-lease-accounting-standards.html

PwC, Nearly a Quarter of Companies Slow to Start Adoption of Lease Accounting Standards, https://www.pwc.com/us/en/press-releases/2017/pwc-and-cbre-survey-lease-accounting-standards.html

#3 Design a process roadmap: Begin by chalking every process, its owners, and their responsibilities in detail. The process framework should identify timelines for each bit, detail the standard operating procedure, and also how to handle unexpected scenarios.

#4 Select the right technology: There’s no one-size-fits-all solution when it comes to technology. Start by defining the specific core accounting and business requirements your organization seeks from a lease accounting software system. Then explore the different options available, discuss customization with software vendors, and map pros and cons of each. Remember the golden rule – whatever can be automated, should be automated. That helps reduce the administrative burden and accelerates the compliance process. Consider web-based automation for workflows, document management, and transaction processing as priorities.

#5 Take the ‘shared services’ route: There’sEngaging a managed services partner to standardize and handle your end-to-end lease accounting operations is one of the best ways to accelerate compliance and ensure ongoing monitoring, while keeping the control of lease budgets and asset movements in-house. It also saves firms the hassle of hiring and training the right people, ramping up office space, managing scalability issues, etc.

Are you leaving money on the table?

Failing to comply with the new lease accounting standards could result in heavy penalties, eroding not just EBITDA and enterprise value, but also market reputation. Forward-looking companies who have already started preparations and are testing the standards stand to reap immense early mover advantage through streamlined leasing operations and holistic visibility. Have you taken the leap yet?