There are words to live by. And words to comply by.
When it comes to guidance on the new lease accounting standard, any words of wisdom from the Big Four is due attention.
And with only 40% of private companies reporting that they’ve begun implementation and another 35% putting it off because of the deferred deadline, there are still many organizations that can benefit from what the world’s leading accounting firms have to say.
Generally, the Big Four echo the common caveat that the FASB ASC 842 implementation process will be more time and resource intensive than expected. And their basic advice is much like that of the majority of accounting professionals industry wide:
- Start the process now, if you haven’t already.
- Assemble a multi functional team who will meet early and often.
- Make sure accounting spends adequate time on the approach, policies and procedures before involving IT.
- Involve auditors in the process.
- Assess your IT capabilities.
- Consider updating or on-boarding lease accounting software.
All are suggestions worth repeating (and heeding), but a deeper dive into selected resources published by Ernst & Young, PwC, Deloitte, and KPMG reveals some valuable insights you may not have come across yet.
We sifted through the volumes of granular information the Big Four have authored regarding the new lease accounting standards and mined some worthy bits related to four different areas of the implementation process: Diagnosing your needs; identifying assets; embedded leases and disclosures.
Ernst & Young on Diagnosing the Situation
The experts at Ernst & Young agree with the prevailing notion that the obvious starting place is to gain a thorough understanding of the new lease accounting standards and their impact on your lease accounting.
It’s what you do next where they suggest an extra step.
Most of the FASB ASC 842 compliance guides recommend pulling together a team from accounting, procurement, legal, IT, operations and any other relevant stakeholders early in the process.
But in E&Y’s The Private Angle, they suggest that even before selecting your project team, take the time to assess whether your company has sufficient resources and the competency to implement the standards effectively.
The implementation process will be less of an endeavor and can likely be accomplished internally with a few key people if your specific situation is less complex.
Ask these questions to determine low complexity:
🗸 Are our operations highly centralized?
🗸 Is leasing a significant part of our operations?
🗸 Do we use established processes to track our leases?
🗸 Do we use standard contracts?
🗸 Is our volume of contracts low?
If you answered yes to the above list, you’ve got the green light to assemble your team.
Conversely, if you answered no, you’re looking at a more complex process that will most likely require more time and resources, and possibly the services of an external advisor.
PwC on Identifying Assets
ASC 842-10-15-3 states that “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 example, the number of production units that an item of equipment will be used to produce).”
Identifying an asset seems straightforward enough, but there are countless scenarios where that “identified asset” isn’t so easy to pinpoint. According to PwC’s updated 2019 Leases Guide, there are three criteria to use in determining whether there is an identified asset within a lease or contract:
- The asset is explicitly or implicitly specified.
- The asset is physically distinct.
- The lessor or supplier does not have substantial substitution rights.
Explicitly specified asset
The contract includes an identified asset if it specifies an asset by a serial number, a specific floor of a building or some other unique identifier. Also the supplier cannot have substantive substitution rights.
Implicitly specified asset
This type of asset is a little trickier to identify. There could be an implicitly specified asset when a supplier requires use of a particular asset in order to meet obligations included in the contract. For example, a manufacturer is contracted to fabricate a specific part of a product and uses dedicated equipment solely for that production task.
As with explicitly specified assets, the supplier cannot have substantive substitution rights.
This could mean the entire asset or simply a portion of it. For example, one floor of a building might be physically distinct if it can be used independently with its own entrance/exit and access to required facilities such as bathrooms.
It also helps to think about how the asset was intended to be used. If a cell tower is constructed to rent or sell space to carriers then the specific location on the tower would be considered physically distinct.
Substantive substitution rights
If substitution rights exist, then it may mean that a specific asset hasn’t been identified.
In the case of an implicitly specified asset, if an alternative asset isn’t available for the supplier to fulfill the contract, then there are no substitution rights, resulting in an identified asset.
On the other hand, in a contract with an explicitly specified asset, if the supplier has the right by the terms of the contract to make a substitution, the two parties would need to take a closer look at ASC 842-10-15-10 to evaluate if those rights are deemed substantive.
Deloitte on Embedded Leases
The accounting executives at Deloitte urge companies to be diligent as they search for and accurately account for embedded leases. These are contracts, many times service agreements often not even containing the word lease, that contain a leased asset and must be reported under FASB ASC 842.
Deloitte recommends the following practices:
Closely examine all operations
Start with meeting with all relevant departments to get an understanding of the types of contracts they have. Share your knowledge of the concepts of the new lease accounting standards and how a lease is defined. Instead of technical accounting jargon, use language that non-accountants will understand. Rather than simply asking if they have any embedded leases, explain what the term means and give an example.
Perform a risk assessment.
Create a list of questions that could lead to identifying the areas likely to have embedded leases: Do you contract out the manufacture of a specialized product or part of a product? Is your organization required to adhere to any OSHA regulations that need dedicated equipment? And how about maintenance contracts associated with property leases?
Examine general-ledger expense activity. Look for recurring monthly or quarterly payments that may need to be analyzed.
Conduct an inspection
Sometimes simply walking through offices and manufacturing facilities will lead to discovering leased assets that for some reason or another didn’t show up on a list.
With help from your legal department, identify contracts that should be reviewed.
KPMG On Discount Rates
Although ASC 842 carries over “rate implicit in the lease” and “incremental borrowing rate” from ASC 840, the terms are interpreted a bit differently in the newer guidance. From the KPMG perspective, it’s important to note the distinction, especially with regards to the implicit rate.
The experts at KPMG expect that most lessees will end up using IBR.
And the reason starts with the difference between readily estimable and readily determinable.
Under the new lease accounting standard, lessees must discount their remaining unpaid lease payments using the rate implicit in the lease when it can be “readily determined,” a term which is left undefined in Topic 842.
However, “readily determined” is used in other parts of US GAAP in the context of deciding on fair market value by using published market quotes or published determined prices--which makes determining that value much easier than estimating it.
The rate implicit in the lease is usually not published. Because it’s an internal measure involving data--and estimations--that likely only the lessor knows, it will be difficult for a lessee to determine it; therefore lessees will use the incremental borrowing rate for almost all their leases.
Conclusion: Expert Advice Smooths the Way
Whatever phase of implementation you’re in, there’s a wealth of information to guide you into the next one. Just make sure the source is knowledgeable and trustworthy.
Advice doesn’t have to come from the experts in the corner offices at the Big Four either. Coast to coast, there are accounting professionals and lease accounting software providers who’ve studied the new lease accounting standards with all their complexities.
Here at AMTdirect, our team has put together a variety of resources to help private companies through the implementation process more efficiently.
White Paper: The FASB 842 Cheat Sheet to Lease Accounting
These easy-to-digest resources are packed with helpful information, but if you have other questions or would like to see a demo of our lease accounting solution, we look forward to talking with you. With over 20 years’ of technical expertise and hundreds of completed projects, we can help you transition to the new lease accounting standards with confidence.