The deadline to implement the new lease accounting standards, ASC 842 and IFRS 16, is quickly approaching. Public companies with a fiscal year end of December 31, 2018 will be required to implement by January 1, 2019. With the deadline so close, many organizations are understandably focused on achieving compliance. However, an equally important consideration is how to maintain compliance after the deadline has passed.
Consider the following scenario: Your implementation project team tracks down all your leases, uploads all the right data into your lease accounting system, and tests the accuracy of your financial reports. Everyone breathes a sigh of relief as you enter the new year on 1/1/19. But if you have not set up the day two processes, systems, and controls, your accounting could quickly become inaccurate.
Suppose that on 1/2/19, the IT organization signs a new lease for 10 pieces of data center equipment. Will the accounting team be notified of the new lease? How will accounting capture the relevant data necessary to perform the initial classification, recognition, and measurement?
Tracking a handful of new leases each month may be possible without much investment in processes, systems, and controls. However, tracking a few hundred or thousand per month will not be. A company with a portfolio of 10,000 leases might have changes to 3,000 of those leases each year, especially if there is a concentration of short-term equipment leases.
Companies need to not only monitor new leases, but also existing leases that have pricing and contractual changes that could lead to modifications and reassessments. Leased assets that reach the end of term will need to be renewed, terminated, or purchased. Companies will also need to track new subleases, sale-leaseback transactions, and embedded leases contained in outsourcing and service contracts.
The Key to Maintaining Compliance: Future State Design
Unless you already have strong processes, policies, and controls in place to handle the new lease accounting standards, you will need to focus on designing the future state of your leasing program. It’s a difficult task, but there are some steps you can take now to ease the process of transforming your leasing program.
Identify Your Current Processes
The first step is analyzing the current state of your leasing program to identify weak spots, and then designing solutions to fortify those areas. To start, consider whether you have processes in place for three key audit assertions: Completeness, accuracy, and existence.
- Completeness: Do you have a process in place to capture every new lease that is signed? If you do not, the accounting organization will always have to catch up with the actual lease portfolio, much like they had to do during the lease identification phase of the implementation project.
Consider working with Procurement to create a process to capture new leases as they come in. Procurement will touch each new lease, as well as service agreements that may contain embedded leases. If Procurement is trained to identify contracts that might be a lease, they can pass those contracts onto Accounting for further analysis and upload into the system.
- Accuracy: Do you have a process in place to keep data on your leased assets up-to-date? There are situations that can occur throughout the lifecycle of a lease that can cause changes to the accounting, like reassessments, remeasurements, and modifications. For example, you may have to revalue the right-of-use asset and lease liability if lease term increases or decreases.
Consider periodically requesting attestations from asset owners on the current state and plans of each asset on lease. This will allow you to determine if any data, like end-of-term plans, has changed.
- Existence: Do you have a process in place to ensure that every lease recorded in your system still exists? At many organizations, it’s common to see asset users inconsistently reporting their end-of-term decisions, like renewing or terminating a lease, to back-office groups. This could lead to several issues. First, if Accounts Payable is not informed that the lease term has ended, they could continue making payments on it. Another possibility is that Accounting could continue to include the lease in the balance sheet valuation. When Accounting later realizes that the lease no longer exists, they would have to make a prior period adjustment.
To better track an asset’s existence, consider setting up an incentive program to encourage asset users to report their end-of-term asset decision. For example, if an asset user helps eliminate an evergreen payment (paying for a lease past the end-of-term), that expense can go back into their budget.
Determine System Features and Staff that You Will Need to Maintain Compliance
Scaling a lease accounting program on day two and beyond can be accomplished by investing in either new systems or additional staff. Most companies will use a combination of both. However, project teams will need to make a choice about how much they want to invest in technology to automate business processes versus how many personnel they want to add.
- Investing in Accounting Staff: Some companies will opt for a lower cost lease accounting system to fit into their project budget. To compensate for the limited feature set of the system, they may hire more staff to handle aspects of the record-to-report process. For example, these companies may elect to perform asset tracking processes by having lease administrators call and email asset users to verify the existence and status of leased assets. Additionally, these companies may perform some of the reporting necessary for the new quantitative disclosures using spreadsheets. These manual workarounds can lower initial project costs but will make it difficult to adopt and maintain best practices. They also introduce risk that would not exist using an automated solution.
- Investing in a Technology Solution: Other companies will elect to purchase a more sophisticated lease accounting application. While these systems will require a higher upfront investment, they may offer a lower long-term cost by reducing the number of new employees required to support the lease accounting program. Along with push-button reporting for the new standard, a complete lease accounting software solution can automate many necessary processes. A complete solution will allow for:
- Customizable Policies - You should be able to set a policy to require high-value asset requests to go through a lease versus buy analysis. This will allow you to create a record of all high-value assets on lease. Automation also allows for an audit trail, file backup, and versioning.
- Notifications – You should be able to automate asset tracking processes. For example, the lease accounting system could periodically email notifications to asset users requesting them to attest to the existence of assets as well as the completeness and accuracy of the lease population.
- Integration – You can integrate the lease accounting application with the IT, Fleet, and Real Estate asset management systems. Integrating will allow both the lease accounting software and the asset management software to remain up-to-date with each other as changes occur.
Hiring staff and deploying systems are both viable options, but investing in software will reduce the risk of manual error by automating many of the processes, policies, and controls needed for compliance.
Budget for the Future
No matter which approach you choose, maintaining compliance will cost. How much it costs will likely depend on the size and state of your lease portfolio. However, a well-maintained lease portfolio can also generate savings.
For example, notifying asset users of approaching critical dates, such as a renewal option exercise date, will allow them to make the optimal economic decision for the asset in a timely manner. Requiring asset users to report their final decision on whether to exit or renew a lease will also ensure that Accounts Payable does not continue to pay for equipment or a property that is no longer on lease. In addition, improved tracking of asset data will allow you to analyze your lease terms to determine how competitive they are – knowledge that will help in future lease sourcing negotiations.
Designing the future state of your leasing program will be a significant challenge, but a sustainable strategy will streamline future lease processes and allow you to maintain accurate accounting. You may also find that your new processes automatically generate savings that will help make up for the costs of compliance. The most important takeaway is to start developing these processes now. You don’t want to reach your first quarter close after the effective date only to find that your reported lease portfolio is no longer accurate or complete. Effective lease processes will help you avoid risks like material weaknesses, prior period adjustments, and delaying the close.
Colleen Tigges, VP of Global Solution Consulting