If your firm is adopting the lease accounting standard for the first time, there is an endless sea of information available to learn from. It can be overwhelming to sift through the technical and practical guides, some of which contradict each other when it comes to the treatment of less common lease situations. Whether your business conditions are simple or complicated, here are five things to know about ASC 842 / IFRS 16 / GASB 87 adoption:
1. Accounting calculations are a small part of the overall effort. The calculations themselves are relatively simple once you become familiar with the technical concepts behind right of use assets and lease liabilities. In addition to consulting your outside auditors, substantial effort is needed to get to the point where calculations can be performed, and effort is required from others beyond just the corporate accounting team. Procurement, real estate, human resources, technology, treasury, administration, and other functions have ownership of components of the data needed to perform the accounting calculations. Their contributions often include tracking leased asset activity, identifying embedded leases, and making assumptions about future events – all of which are needed to properly calculate the balance sheet impact of leases.
2. Leases are everywhere. Often, organizations think that the majority of their leases are for real estate assets – land, buildings, and parts of buildings where they physically conduct business. While these large ticket leases are the easiest to identify, do not discount leases for other non-real estate assets. From printers and copiers, to computers and furniture, to warehousing and distribution, to fleet automobiles and trucks – many of the tools that we use daily in business have the potential to be leased items. Even service contracts such as third-party logistics agreements and warehousing agreements can have leased assets within them which need to be identified and accounted for. By quantity, leases of smaller assets far outnumber the leases for real estate, even though the financial obligation related to non-real estate assets is often less material. To comply with the standard, all leased assets must be identified and supporting documents located to determine the appropriate accounting treatment. Applying a materiality threshold could lessen the burden for identifying leases of small value items and should be discussed with your auditor if this is applicable.
3. Lease documentation quality is critical to success. Read that one more time – this point cannot be stressed enough. The first, painful lease accounting hurdle for many companies often involves lease documentation. Undocumented soft commencement dates create questions in real estate leases, especially for those leases that were acquired from outside entities. For equipment populations, identifying the leased asset population can be the first challenge. The search for contract documents to support those lease obligations can be very difficult, time consuming, and cause delays from the very beginning. All leases and service agreements must be located and evaluated to determine whether the lease obligations should be reflected in the financial statements. This includes leases for assets located in international offices and those contracts that might have been executed outside of the normal procurement process. Without copies of the contracts, accurate calculations cannot be completed or supported should an audit occur.
4. There is no single right way to implement the lease accounting standard. Even though we are well past the initial adoption date for public companies, application of the lease accounting standard can still be inconsistent amongst similar entities and lease situations. Financial materiality, the ability to locate documentation, and subjective inputs vary widely from company to company and affect the calculations behind the reported assets and liabilities. That being said, consistency over time in applying the accounting standard matters. Changes to internal policies around lease accounting should be made thoughtfully and infrequently so that valid comparisons can be made from period to period. When planning for your adoption project, always consult with your auditor. Ultimately, they need to be comfortable with the plan to become compliant, the decisions made, and the controls put into place during the first and subsequent reporting periods.
5. Compliance goes beyond the initial adoption date. The push to gather information and complete the first round of lease accounting calculations is only the first step. Maintaining compliance requires ongoing diligence, especially for portfolios that have assets continually moving in and out of service or leases that turn over regularly. During the initial adoption project, it can be helpful to keep track of where leases are found to spark ideas and conversation around how to best capture them going forward. Some options might include creating a center of excellence for leases, revising workflows and processes, investing further into technology, and evaluating the overall cost versus buy analysis for smaller assets to include the increased administrative costs related to accounting for leases. Think ahead, so that every reporting period does not result in a special project focused on capturing and recording interim leasing activity.
These are just five of many things to consider when adopting the lease accounting standard. The deadline for private organizations to comply with the standard is fast approaching at year end. Don’t hesitate to seek knowledge and expertise from those that have already worked through this endeavor and create a team that you trust will get the job done. With proper planning and a solid multi-functional group effort, not only will you be in the best position to meet your first reporting deadline, but you will also develop the necessary structure and controls to continue to account for your leases for years to come.
Scribcor Global Lease Administration is committed to helping clients with abstracting and managing their lease data on a project and ongoing basis. Interested in how Scribcor can help you with your lease project? Contact us today!