Recently, we have been having a great deal of discussion around equipment leasing and the effect of the new accounting standards on that segment of business activity. Our work with our real estate client teams has naturally focused on the accounting changes for real estate leases, but since the new accounting standards reach beyond real estate we are also having discussions around equipment leases too. While the consensus is that adoption of the new standard for real estate will have a large and expensive impact on corporate and private entities, it appears that this impact might just be the tip of the iceberg when you consider leasing activity outside of real estate.
We are receiving calls from companies large and small that are concerned about the state of affairs of their leased equipment portfolio. The concerns are as in the weeds as not knowing how many leased assets are under contract and as above the trees as evaluating overall leasing strategies for equipment assets given the complexities and demands of the new lease accounting standard. Forget about the idea of simply determining who the stakeholders are in the leasing process and working toward accounting compliance; these are sophisticated corporate entities that don’t know what assets they have under lease, where they are located, how many contracts exist, where the contracts reside, who approved the contract, when the contract expires and how are these assets currently tracked.
And in a way, it makes sense. Real estate costs are typically large dollar expenditures, supported by an entire centralized team of professionals dedicated to leasing, constructing, operating, tracking, modifying and disposing of the space used to conduct business. Equipment leases, on the other hand, tend to be executed in a decentralized environment – either in a field office or in a regional office but rarely with the organizational structure around it like that which exists for commercial real estate. The equipment assets themselves are individually smaller in value, but there are more of them. This type of decentralized approach has worked for years. But with implementation of the new lease accounting standard, it will not continue to work if accounting compliance is the goal.
If the current state of affairs includes executing and administering equipment leases in a decentralized environment, on spreadsheets that are combined in some manner for financial reporting purposes, companies need to consider how the decentralized accounting calculations will be consolidated for monthly / quarterly / annual reporting going forward. Especially since the new accounting standard requires asset level accounting; that is, the generation of debits and credits on an asset by asset (not contract by contract) basis. I am an inactive CPA and thinking about manually preparing these calculations asset by asset for more than a very small portfolio of leased equipment makes my head spin. I cannot imagine gathering reliable accounting data resulting from complicated calculations manually prepared by field personnel who are not well-versed in the ways of lease accounting.
Now that the challenge is identified, what is the opportunity? There is opportunity for companies that are willing to approach this compulsory accounting change in a pro-active, well-planned and integrated manner. This effort will likely require more time and effort than making the accounting change for leased real estate assets because the lease contract population for equipment first needs to be identified, documents gathered, data abstracted and calculations automated – all of which already exists for most real estate groups. Much of the equipment lease data exists in a decentralized, sometimes globally decentralized environment today.
To get to the opportunity benefit, this effort first needs a champion often in the form of an executive who will embrace the accounting change and provide encouragement and backing when change management gets tough. The effort also needs a strong internal project manager or external consultant to coordinate and oversee the activities of several different disciplines. The change itself may involve a complete overhaul of equipment leasing practices, selection and implementation of a database system to track all the information needed to complete the accounting calculations, gathering, cataloguing and scanning of documents, abstracting data from the leases, testing and creating calculations. That is just to generate one set of calculations. There will also need to be historical comparative calculations prepared and new processes and procedures created around capturing and maintaining the data going forward.
Back to the opportunity. The compliance project is complete and all equipment leases are entered in a lease administration system. Let’s assume that everything is working optimally and there are no large concerns to be dealt with. There could be better control over spending because the administration is centralized. There might be volume savings to be gained by executing larger leases that cover larger groups of equipment. There may be significant savings due to better end of term reporting – fewer hold over charges and fewer evergreen fees. There is also the ability to make operating decisions prior to contract expiration – proactive vs. reactive actions. The total of these ideas could provide financially significant savings.
Beyond operational opportunity, there are automation opportunities as well. Centralized asset tracking could lead to less inventory shrinkage due to theft or lost assets. The accounting calculations will be done by computer and take minutes as compared to months if done manually. Even revised accounting calculations will be automated provided the data is kept current for events that might trigger a re-calculation of the lease assets and liabilities. And control over the process and data will be greater having the calculations centralized and performed by a system, which eases the auditors’ minds once they get assurance that the computer is doing its job accurately. These opportunities, too, can be significantly beneficial to business entities.
It is time to critically evaluate the effort that will be needed to comply with the new lease accounting standard for both real estate and equipment assets. Chances are that more effort will be required in working with equipment leases in a decentralized environment. Begin to lay the groundwork now by identifying the entire lease population, locating and gathering documents and looking at system solutions. There is no need to panic, but even the largest professional services firms will have capacity limits if you need outside assistance. Prepare, plan and seek outside support to get the most effective and customized lease accounting solution for your organization.