Private companies with a calendar year-end have until Jan. 1, 2020 (or varied dates thereafter, depending on whether they have a fiscal or calendar (year-ends)) before Accounting Standards Codification 842, the Financial Accounting Standards Board’s new standard on lease accounting, becomes effective. However, the compliance efforts of public companies—which had earlier deadlines for compliance (and varied depending on their fiscal or calendar year-ends)—offer some lessons private companies should learn.
Notably, they learned that the complexity of the preparation effort can be substantial and, perhaps not surprisingly, the time required to implement the standard exceeded all expectations. Automotive manufacturers and suppliers should take note.
There are specific technical accounting challenges being encountered with the implementation. In addition, companies found it difficult to identify and implement the systems needed to support adoption of the standard and maintain its ongoing accounting and disclosure requirements.
Following are three areas where the experience of public companies can help private OEMs and their suppliers:
1. Underestimating challenges
Across the board, companies underestimated the effort and time required to implement the standard. The process for centralizing copies of all contracts and related amendments requires a significant commitment of resources and time as well as a dedicated attention to detail. The evaluation and documentation of service arrangements in the context of the lease guidance can be time consuming.
In particular, automotive OEMs will need to evaluate whether the right of an automotive supplier to substitute the use of a dedicated production line for an alternative production line is substantive. The OEM should assess whether the supplier has the practical ability to substitute an alternative production line throughout the period of use as well as whether the supplier would benefit economically from doing so. Interviews with the business should be conducted regarding the existence of substitution rights and how the assets in a contract are utilized and maintained. This can be challenging and time-consuming work that should be budgeted into the implementation plan.
2. Choosing a technology solution
Given the ongoing calculations, reporting and disclosure requirements, many public companies have opted to implement a technology solution to support their compliance with ASC 842. With so many lease solutions available, what are the critical factors for choosing a solution?
Companies often choose technology solutions based on price, functionality, user interface and, of course, the ability of the system to handle ASC 842 accounting. Private companies, including automotive suppliers, should consider asking vendors for information regarding:
- Client references to understand the pros and cons encountered when implementing a system
- The level of support from the vendor
- Key items on the vendor’s road map
- The capacity of the vendor or a third party to implement the system
- The ease of the abstraction process
3. Electing practical expedients
ASC 842 has a number of practical expedients, including a number specific to transition. Automotive suppliers often elect certain practical expedients, especially the optional transition method and the package of practical expedients. But what are the key practical expedients that automotive suppliers are not electing?
There is diversity in practice around the election to use hindsight as well as the decision to separate lease and nonlease components by asset class. By electing not to use hindsight, companies do not need to reassess lease terms and can simply carry forward the lease term based on ASC 840 lease schedules. Some companies have chosen to reevaluate lease terms but the majority has not.
Initially during implementation, companies often decided to separate the lease and nonlease components for specific asset classes, if not all asset classes, with the goal of reducing the right-of-use asset and lease liability. For companies with service contracts that include both significant assets and significant service components, the process of separating the components and getting the standalone pricing has proven to be time consuming and can involve engaging valuation specialists. As such, as implementation progresses, companies often revise their preliminary election and ultimately combine lease and nonlease components.
Private companies should plan to leverage these key lessons and plan to dedicate enough time in 2019 to the new lease accounting requirements.
