Many real estate leaders are just starting to ask questions about new lease accounting planning, data consolidation, budgeting, disclosure requirements and selecting new technology for compliance.
Originally Published February 27, 2018 by Real Estate Finance & Investment.
The accounting departments of businesses across the United States will be working throughout the year to meet the new lease accounting compliance rules. After a decade of discussion, in early 2016 the Financial Accounting Standards Board (FASB) issued the most significant change to financial reporting for leases in 40 years. For the first time, public companies will be required to recognize the majority of leases as assets and liabilities on their balance sheets for all financial reporting after December 15, 2018. Non-public companies have an extra year, but the compliance deadline for the new standard – known as ASC 842 – now looms over accounting departments.
This is not the only recent change to accounting standards, leaving many companies concerned about meeting the upcoming deadline. These new lease accounting standards were announced by the FASB soon after also issuing challenging new requirements for revenue recognition (ASC 606).
As of Q3 2017, a PwC and CBRE survey estimated that up to 75 percent of businesses either haven’t started on lease accounting compliance or are still in the assessment phase of the project. Many executives are just starting to ask questions about new lease accounting planning, data consolidation, budgeting, disclosure requirements and selecting new technology for compliance.
Compliance isn’t just a matter of presenting information differently by the correct date. There are a number of significant steps to take before the FASB guidelines can be adopted. SAB74 requires SEC registrants to disclose and discuss the projected impact of new accounting standards in notes to their financial statements. Many companies have included qualitative and quantitative descriptions regarding the change for fiscal years ending from late 2015 to early 2017. The wording below is an example:
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This new standard increases transparency and comparability by recognizing a lessee’s rights and obligations resulting from leases by recording them on the balance sheet as Right of Use (ROU) Assets and Lease Liabilities. Leases will be classified as either finance or operating, which will impact the pattern of expense recognition on the income statement. This ASU is effective for us beginning in the first quarter of 2019. A modified retrospective transition approach is required for leases existing at or entered into after the beginning of the earliest comparative period presented. Through we are currently evaluating the impact, we expect the new standard to have a material impact on our consolidated financial statements, particularly the balance sheet impact associated with ROU assets and lease liabilities on operating leases.
As the deadline approaches, registrants may also need to include more robust quantitative disclosures. One option to consider is including projected ROU asset and lease liability balances. Other disclosures could include discoveries related to the new standard that impact business decisions, such as restructuring debt covenants or reevaluating lease versus buy decisions.
ASC 842 originally required two years of comparative lease data, which essentially moved the deadline for tracking lease information to December 15, 2016. The FASB recently announced a tentative decision to relax this “look back” period requirement so that only current lease data as of December 2018 would be necessary for compliance.
While this decision may provide companies some relief in their compliance efforts, there are still four major challenges for meeting the new standard. To be fully compliant, most companies still must (1) set new accounting policy, (2) collect lease data, (3) select a software solution for reporting, and (4) implement new processes to manage lease data going forward.
Other challenges that companies should be wary of include absences of key personnel during holidays and vacations, year-end close efforts, SOX compliance freezes, and “code freezes” when IT departments restrict the implementation of new technology. These are in addition to other unexpected delays and challenges.
Even without the delays and comparative data requirement, data collection for current leases remains the biggest challenge for most organizations. Implementing new software with integrations to existing systems could also take six months or more. CoStar and other industry experts continue to stress the importance of not letting more time lapse before pushing ahead on lease accounting compliance projects.
Compliance Can Cost
Compliance will be costly. The PwC and CBRE lease accounting survey also found 24 percent of organizations did not know their total costs for compliance. Forty-three percent of businesses believed their costs would be less than $250,000, while 33 percent estimated costs would be higher.
To get a handle on budgeting for new lease accounting compliance, it’s best to break down associated costs into three broad categories: Policy Setting, Data Collection & Review and Technology Solutions.
Policy setting is a key first step in the process. Because the new accounting guidance is technical in nature and involves many changes to existing policies, companies should first obtain a full understanding of the new guidance and develop a plan of how it will impact accounting policy. If this is not done before data collection, there is a risk of collecting too much, not enough or simply wrong information.
No current lease accounting policy documentation may exist regarding current standards. However, a policy for the new guidances may be a 20 – 40 page document, requiring 80 hours to create and 40 hours of internal review and approval. A best practice is to utilize resources to obtain an understanding of new guidance. Then, policies should be drafted applying the general guidances from authoritative literature into company specific accounting policy.
Any new policies should be reviewed with company auditors to ensure there are no surprises at audit time. This step would, of course, add more billable hours for review and discussion.
Data Collection and Review
After policy setting is complete, the data collection process should begin. Many companies use a project management approach during this process, utilizing internal or external teams. Because leasing data is generally fragmented across the organization, data collection can be a time consuming and costly exercise. However, establishing a plan upfront based on solid policy will help avoid wasted time and expense.
Real estate lease documents can contain more than 100 pages of details, requiring two to three hours of examination time for sufficient lease abstraction. Simply reviewing leases for necessary reporting data and options may take 30 minutes each. This could mean budgeting thousands of hours of work for a complete data collection and review project. An organization with 1,000 leases may need to allocate 2,500 hours for thorough review and re-abstraction of critical lease information.
Equipment Leases Can Be More Difficult
Many companies are discovering that, while real estate leases make up the bulk of the total financial impact, equipment leases are actually more difficult to work with in the data collection process. This is usually due to the fragmented nature of equipment leasing practices at many organizations.
As the deadline approaches, organizations with a voluminous amount of leases may need to enlist outside resources to help abstract information, convert paper documents to electronic, and test for data integrity. Use of outside consultants will most likely ramp up as the deadline approaches and resources are constrained, resulting in higher costs for external resources. Companies need to budget for and engage qualified consultants early before lack of availability and high billable rates become unwelcome challenges.
Establishing a new or upgraded technology solution is essential for the new lease accounting environment. While many companies got by with manual reports and spreadsheets under ASC 840, the complexity of calculations for accurate reporting and audit trails of data under the new guidance makes lease accounting software a sound requirement for compliance.
The full cost of lease accounting compliance will vary by company, depending on specific needs around policy setting, data collection and technology. But by addressing these areas, organizations can meet compliance goals while also controlling costs. The key is to start now to limit timing based expenditures as the deadline approaches. With less than four quarters to go, time is of the essence.