It’s already halfway through Q1. Time is definitely ticking away.
The number of days left to complete your transition to the new FASB standards is quickly dwindling--although there is that one extra day for Leap Year.
In fact, it’s so important that it bears repeating.
The time to begin your transition is now.
Transitioning to the new lease accounting rules is a complex endeavor that can take companies substantially more time and resources than they originally planned for. In a survey of both public and private companies by KPMG, 75% of respondents reported that they were facing challenges with implementation, leaving only 25% who said they were on schedule.
To eliminate some of those challenges and facilitate a smoother, more efficient process from start to finish, we offer these 6 tips.
# 1 Pick the Right Team
Assembling a cross-functional team composed of the appropriate people is possibly the most important step you can take to ensure your transition to the new FASB standards progresses in an organized, timely manner.
This group will drive the process, determine critical timelines and ultimately carry the responsibility of compliance all the way through completion of the project.
In general, the team should be made up of individuals from departments that administer leases, lease equipment or use leasing information. At least one person on the team should have an understanding of the full scope of your company’s contracts, not just those agreements that are identified as leases, but any service contracts or arrangements containing embedded leases that can easily be overlooked.
It should also include representatives from the following departments:
Accounting: Because Accounting understands the requirements for financial reporting and lease accounting, their experience is essential for successful ASC 842 implementation. Usually it makes sense for a senior manager from this department to spearhead the project. This person will most likely be responsible for interpreting the new lease accounting rules and play a significant role in choosing your lease accounting software solution and in defining new accounting policies.
Real Estate: Their familiarity with your portfolio of leases makes them an obvious place to look for team members. They are the source for information on property lease terms and payments as well as plans for possible expansion of your company’s portfolio. Also, if you have any sublease or sale-leaseback arrangements, they will be the ones to know the details.
IT: Their value is twofold. First, they will have knowledge of leases associated with office equipment such as copiers, computers, software and servers. Secondly and more importantly, their expertise is especially needed when it comes time to evaluate the capabilities of your existing systems and define what upgrades you’ll need. Or if the purchase of lease accounting software is called for. IT’s understanding of systems integration ensures a seamless and complete flow of data.
Procurement: Because many companies lack a centralized repository for leases other than real estate, these key people are crucial when it comes to providing the data regarding leases for vehicles, equipment, furniture and the like. Additionally, as they usually negotiate the price and terms for new equipment leases, their input may influence decisions later on in the process.
Property Management/Lease Administration: You’ll need someone who knows details such as how CAM charges are allocated or how your company handles equipment partial end-of-term buyouts. And that person will likely come from either of these departments.These team members deal on a daily basis with your processes for data input and more.
Financial Planning/Treasury: As the owners of your company’s financial strategy and policies for leasing, they bring the ability to forecast the cost of leases and budgetary oversight. And because their goal is to ensure the company is making optimal use of its cash and external financing sources, their lease versus buy analysis and other insights are invaluable.
Legal: It’s beneficial to include a member from the legal department, if you have one, to lend their expertise with contractual agreements.
Because the new lease accounting rules are principles-based rather than rules-based, key decision-makers, especially those that will be charged with creating your new accounting policies and procedures should have the ability to make judgment calls about which practical expedients to elect, discount rates and other aspects of the new FASB standards.
Ideally, your FASB transition team members will all possess the qualities that make them an asset to any team: good communication skills, project management experience, detail-oriented thinking and the time to fulfill their obligations to the project while still completing their regular tasks.
One final note on selecting your transition team. If you assess your internal capabilities and determine that you lack the manpower or expertise for this critical project, it’s wise to seek external resources earlier rather than later in the process.
# 2 Pick the Right Technology
Not every private company preparing for ASC 842 implementation needs to purchase lease accounting software, but if you have 10 or more leases--and that includes leases for vehicles, equipment and other ROU assets--then you really should consider using an automated solution.
Keep in mind, too, that the new lease accounting rules not only require complicated calculations, but more frequent monitoring of your lease-related activities. You’ll need triggers to alert you to the need for reassessments, modifications and new leases. These events affect your lease accounting throughout the reporting periods.
Depending on spreadsheets and piece-meal systems to handle all this complexity opens the door to errors, missing important deadlines and perhaps the risk of an audit. Lease accounting software accurately makes the necessary calculations and tracks and updates your data as needed.
If after all these considerations, you come to the conclusion that an automated solution is a smart move, then start evaluating lease accounting software solutions early in your process.
Here are some questions to ask vendors during your vetting process.
Has the solution been validated by financial reporting experts and CPAs?
Though the screens you see in a demo may look simplistic, the actual calculations are complicated. Insist on a solution that’s been scrutinized by financial pros. It’s even better if some of the big accounting firms have recommended it.
How many active implementations do you have going now?
You want a provider who has experience with implementation, especially for companies similar to yours in terms of size and industry. Not one that has jumped on the compliance bandwagon because the shortage of lease accounting software providers has opened an opportunity for them to enter the market.
Does your solution also support ASC 840?
It might seem odd to ask if their product supports guidance that will soon be obsolete, but this is another way to learn if a vendor is new to the business. Again, you want them to demonstrate experience with lease accounting and administration. If their solution does not support the current guidance, that’s a glaring indicator that they’re new to the game and you should look elsewhere.
How long will implementation take?
There’s no right answer because it depends on your specific needs and their availability, but beware of providers who promise a really short timeline.
What ERP and accounting systems do you integrate with?
Obviously a software solution that integrates with your current accounting or ERP system is preferred. But a robust solution that integrates with a broad range of solutions is a good idea. You never know how your needs may change in the future.
Does the solution track data changes and keep an audit trail?
As lease accounting is going under the microscope, you want a solution with strong security settings, second party approval and the ability to provide an audit trail that identifies when and who made a data change.
What are the solution’s reporting capabilities?
Solutions that offer both standard reports and those that are easily customized are best.
What kind of support can we expect?
Look for vendors who have the experts in-house to help with each phase of implementation, including training your staff.
Can I see a demo?
Ask to see a demonstration of their software. Have some specific scenarios for the vendor to run so you can see how the solution would work for you. Of course you want a solution with a user-friendly UI, but you’ll also want to work with a vendor who has user-friendly support in terms of their people.
# 3 Make Sure Your Inventory is Complete
One of the more time-consuming aspects of the implementation process is creating an inventory of all your existing leases. The process starts with locating all your real estate, vehicle, equipment and embedded leases, which is challenging because they can be housed in different sites, formats and systems.
If you’re like most private companies and don’t already have your leases in a central electronic repository, your team will be mining through paper files and reaching out to various business units that may be located in different geographies to discover each and every lease.
Even after you think you’ve located all your leases, you may need to do some more digging. Some agreements that wouldn’t have been considered leases under the legacy guidance may qualify as such according to the way a lease is defined under the new standards.
So what seems like a straightforward task actually requires some analysis and an organized method of investigation. All contracts will need to be examined to see if they contain or are a lease according to the new definition:
“A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. A period of time may be described in terms of the amount of use of an identified asset.”
For each contract in question ask the following to determine if it is indeed a lease:
Is there a specifically identified asset? (Yes)
Does the supplier have a substantive substitution right? (No)
Does the customer have the right to obtain substantially all of the economic benefits from use of the asset? (Yes)
Does the customer have the right to direct the use of the asset? (Yes)
If your answers are as indicated then the contract is a lease and should be accounted for as either a finance or operating lease on the balance sheet--unless its terms are 12 months or less. Short-term leases are exempt under FASB standards.
Watch out for embedded leases.
These are service agreements or contracts that may not even contain the word lease but still must be included in your financial reporting. In order to find embedded leases, you’ll need to take extra steps, literally.
Examine your operations with a keen eye.
Meet with relevant departments for a two-way exchange of information. Your goal is to educate them about the basic concepts of the new lease accounting rules--without using accounting lingo. And from your colleagues, you want to get an overview of the types of contracts they have.
Conduct a different kind of risk assessment.
Compile a list of questions designed to identify areas likely to have embedded leases. For example, “Are there maintenance contracts associated with any of your property leases?” or “Do you have any specialized products or parts of products that the manufacture of is contracted out?”
Examine expenses to uncover embedded leases.
Review the general-ledger expense activity for any recurring monthly or quarterly payments. These could indicate the existence of an embedded lease.
Perform an inspection of the premises.
You know the saying about finding something right under your nose? After poring over documents and examining contracts, a shift in focus can be enlightening. Taking a walk through your facilities and offices could lead to discovering a leased asset that otherwise may not have been identified.
It may seem like a lot of trouble to find an obscure and perhaps rather insignificant asset, but omitting even just one embedded lease means your reporting is in error.
And that could result in fees or even a restatement.
For each lease identified, include basic information such as vendor name, start and end of contract, the value of the contract and the person in your company who knows where/how the lease is located. After the initial list is done, the next step is to cross-check it for accuracy and completeness.
After you’re sure the inventory is complete, separate the list into categories to make management and analysis more efficient. Doing so will give insight into whether or not you should choose any of the available practical expedients.
# 4 Consider Practical Expedients Early
Some of the practical expedients that FASB issued to offer relief during ASC 842 implementation are meant to simplify the transition to the new lease accounting rules. These include the “package” of three that eliminates the need to re-evaluate embedded leases, reassess the classification of leases and reassess initial direct costs.
Another expedient only to be used during the comparative transition period is the hindsight practical expedient. It allows you to use hindsight when you determine lease terms and can be elected in conjunction with the package or on its own.
The restatement of financials practical expedient was also created to reduce the complexity of the transition period.
The other practical expedients deal with new accounting policies regarding land easements, short-term leases, discount rates, and combining lease and non-lease components.
# 5 Clearly Define Your Lease Accounting Policies
Evaluate the lease accounting policies, procedures and controls you currently have in place. The purpose of this analysis is to identify what changes need to be made in order to be in compliance with the new lease accounting rules.
This will include which, if any, practical expedients were elected and why it was determined that the expedients were chosen. It’s important to do this step before you begin collecting data on your leases. The election of certain practical expedients impacts the number of data points you need to collect for compliance.
# 6 Work with Auditors Through the Process
Throughout the transition to the new FASB standards, auditors provide invaluable insight into current challenges and guidance to minimize complications down the road.
Internal auditors can help with internal controls and processes for the transition as well as with post-implementation financial reporting. To prevent errors on the front end of a process, they might suggest preventative controls like the insertion of a simple question that identifies whether or not a contract contains elements that make it qualify as a lease.
It’s best to keep preventative controls simple and to a minimum. Measures to accomplish accounting compliance shouldn’t cause bottlenecks in your processes.
Additionally, when external auditors are kept abreast of your plans and policies, they are better informed and can help lay a foundation to avoid any hiccups during a future audit. For example, one detective control might be to review a list of all contracts executed and their lease accounting conclusions.
Because auditors want to see your lease accounting systems and processes spelled out in detail, it’s advantageous to have their input when you’re creating them.
Conclusion: Step by Step to the New FASB Standards
No matter how you approach it, the transition to the new lease accounting rules is not going to be a day in the park. It’s going to be more like months in the dark, racing against time.
But by starting now and following a strategic plan that begins with choosing a multi-departmental team to carry out the transition process, you’ll find the road to compliance is doable.
After your team is assembled, they can tackle several tasks simultaneously. Some of what they learn during the lease gathering phase will inform later decisions, which in turn impact what you’ll need in terms of technology. But by no means, should you wait to actively shop for lease accounting software.
If you have questions at any stage of your transition to the new lease accounting rules, our own team at AMTdirect is available with answers. We have over 20 years of experience with lease accounting and administration. Our solutions have helped hundreds of companies streamline their processes and overcome the many challenges of compliance.