Adopting ASC 842 can improve efficiency

Dec 14, 2018
Lease accounting Audit

Companies across industries that are operating under U.S. generally accepted accounting principles (GAAP) have been busy preparing for the adoption of ASC 842, the Financial Accounting Standards Board’s new standard on lease accounting. In addition to the hours and resources that are being dedicated to transitioning to the new standard, investments in technology solutions are helping companies with calculations, process automation, controls over financial reporting and evaluation of contract changes. These significant investments often mean upgrading an old system or hiring an outside vendor.

Those who adopted early are finding there are significant efficiencies to be gained in adapting the new lease management process. Moreover, these companies are finding that there are ways to mitigate the costs of adoption through the organizing principles mandated by the new standard.

A system ready for change

As was the case with fixed assets, the lease management cycle is ripe for both cost reduction and improved returns on capital.

Imagine a company with 10 warehouses scattered across the country. Each warehouse manager independently arranges to lease his or her own forklifts—say, six per warehouse—each with different terms of agreement and costs. Prior to adoption of ASC 842, the costs of these forklifts were not included in financial statements. There was little motivation to include these costs as liabilities; as long as the costs fell below the corporate policy maximum, equipment such as forklifts often were not tracked.

Now imagine that a manager signs a three-year lease agreement for one of those forklifts, wherein the manager agrees, after three years, to keep up monthly payments (this is called an “evergreen” payment) until the lease is formally canceled. With no one tracking the lease or the equipment—and with no incentive to do so—such agreements often expire without anyone noticing; but the payments continue. In a similar scenario, the equipment breaks down, a new lease is set up, and now the company has two leases for one piece of equipment.

The premise of the new standard is to provide management (and investors) with a more comprehensive list of a company’s obligations. These leased assets can be rather significant, particularly when it comes to real estate. But the costs resulting from equipment leases can add up for companies as well, depending on the type of equipment the company uses (for example, technology devices such as servers and routers) and the industry in which the company operates (such as manufacturing, consumer products, health care and distribution).

Opportunities for savings and improved returns

Given the comprehensive accounting and disclosure requirements of the new standard, companies will likely need to supplement their current IT systems or implement new IT systems to address these requirements. There are, however, a number of potential improvements in lease management afforded by the technology implemented for ASC 842. A controlled lease management process—one that utilizes a central information platform—allows companies to reduce cash flow and rely on leasing to a greater extent than may have been possible previously using a spreadsheet-based, decentralized approach. Some opportunities include:

  • Strategic sourcing: Rather than lease equipment using disparate agreements and costs, a system that aggregates company-wide equipment needs can be used to negotiate better prices with a single vendor.
  • Reducing evergreen lease payments: By tracking evergreen agreements, a common clause in equipment leases, savings can be realized by stopping expired leases. A major food processor recently saved more than $8 million in annual payments by stopping these types of payments.
  • Notifications and reminders: The systems set up for ASC 842 can remind executives and managers of upcoming lease end-dates to facilitate decisions regarding extension, replacement or canceling the lease. Periodic notices can remind managers to check on the status of equipment usage and condition.
  • Standardization of commitments: Deciding whether to lease or buy equipment can be based on what may benefit the company as a whole rather than a specific location. Lease commitments can benefit from arrangements that consider equipment in the aggregate rather than as isolated agreements.
  • Visibility of inventory and information: The documentation of inventory that is integral to the new standard will help companies improve the management of their leased assets. It will be especially helpful if an asset changes location or is no longer in use. Time-sensitive reminders can be sent to the appropriate managers regarding contracts that include price escalation (or lowering) clauses.

Not just a compliance exercise

Until now, the lease portfolios in many companies involved relatively little control or planning. As the deadlines for adoption of ASC 842 near, there is an increased focused on pure compliance with the standard. In some respects, this narrow focus is understandable. From gathering leases and designing business processes to implementing accounting technology to training stakeholders, there is a lot to do to prepare for adoption.

But public or private, companies should not look at ASC 842 simply as a compliance exercise. There is an opportunity to take advantage of the system implementation to get a return on investment for the cost of the systems. Companies can put the policies and procedures they need in place now to mitigate the costs of compliance.

Subscribe to Financial Reporting Insights

Stay informed with our biweekly resource for recent financial reporting developments, including AICPA, SEC, PCAOB matters and other finance and accounting compliance considerations.