The deadline is approaching for accounting change. While companies have been focused on the revenue standard, they must now turn their attention to the new leasing standard.
FEI Daily spoke with Steve Thompson, KPMG’s Advisory lead for Revenue Recognition and Marybeth Shamrock, KPMG’s Advisory lead for Leasing, following the release of KPMG’s 2017 Accounting Change survey results. In part two, we discuss the lessons learned from public companies’ leasing standard implementation processes and where the challenges lie. To read part one on the revenue recognition standard, click here.
FEI Daily: The survey noted that 52 percent of companies have started to assess the impacts of the leasing standard, but most have not gone beyond establishing a program management team. Are the remaining 48 percent behind the curve? What can they do to get up to speed?
Marybeth Shamrock: Actually, our survey indicates that 13 percent of our respondents have already completed their accounting assessment. Therefore, there are 35 percent of respondents who have not made progress towards assessing the impacts of the leasing standard. While this is a smaller percentage, it is still a substantial number given that the standard has been released for well over a year. That being said, these companies need to start their lease accounting project as soon as possible. One of the first steps is to establish a program management team so that the project does not get derailed by other priorities. Next, the company needs to perform an assessment which starts with identifying the population of leases and the types of leases through an interview process of key constituents throughout the organization supported by lease contract reviews. Once that is done the assessment should be expanded to include an identification of process, system and data gaps.
FEI Daily: Can you highlight some of the lessons learned from public companies, as discussed in the survey?
Shamrock: The most important lesson is to start early. As we got into the assessment process with our public company clients, we started to realize that the time and effort to identify, collect, and sanitize the data was much greater than anticipated. Companies are finding they underestimated their lease population or they don’t have the right data accumulated on the leases they know they have, thus, causing the process of finding all the right data to be more time consuming than expected. This just reinforces the importance of completing an assessment early.
FEI Daily: Under ASC 842, embedded leases will now need to be separated and reflected on the balance sheet. 49 percent of executives said that identifying these embedded leases was a top challenge for them. Can you explain where the challenges lie?
Shamrock: The challenges are identifying the potential arrangements and then there is management judgment required to apply the literature. As a general rule, an embedded lease exists if there is an explicit or implicit asset in the contract and the customer controls use of the asset. These embedded leases can be in all sorts of arrangements, including many service type arrangements. Once an embedded lease is identified, the contract needs to be separated into its lease and nonlease components and consideration allocated to each based on observable standalone prices. The standalone prices may not be readily apparent and estimates may need to be made. Finally, each embedded lease component needs to be classified as an operating or finance lease – the classification will determine the balance sheet presentation and the expense recognition model. So all along the process, there are estimates and judgments that need to be made.
FEI Daily: The survey noted that 48 percent of executives identified ‘selecting and implementing an adequate leasing system’ as the most significant challenge associated with implementation of the lease standards. What considerations should executives make when selecting a system?
Shamrock: There are multiple leasing software options available and choosing the best solution requires a thorough assessment of business requirements and impacts. Some companies may already have an existing lease administration system to track their leases; however, it is important to understand whether that system has the capability to perform the proper accounting and financial reporting under the new standard.
Some key considerations for selecting a system include ensuring the system: supports dual reporting for US GAAP and IFRS, supports foreign currency needs, captures items required to support new disclosure requirements (i.e. variable lease payments, weighted average discount rate, etc.), supports tracking and recording of the impairment of the ROU Asset, and updated releases will be provided as additional interpretive guidance and best practices emerge. This is not an all-inclusive list but are some key considerations.
FEI Daily: What should executives do if they select a system and realize that it doesn’t suit their needs?
Shamrock: This is why we advise that doing a full assessment, including analyzing accounting, process, and system impacts, is critical before selecting a system. This will help ensue you understand your needs before making a system selection.
To read part one on the revenue recognition standard, click here.•