The road to compliance with Financial Accounting Standards Board ASC 842 can be fraught with challenges. The standard is complex—and implementation could take six months or longer. Gathering and validating data may be complex, especially for organizations with large and diverse lease portfolios. To help with compliance and ongoing management, the following are best practices that can be applied across industries.
1. Know your internal processes and sell the project to the entire business.
Management will want to budget for compliance, but it should be understood that the project is often bigger than they may think. A well-defined project plan—including key dates, roles and responsibilities, and active project management—is essential to a project’s success. Documentation of a company’s procedures regarding the completeness of its lease population should be robust and in a format that can be shared with external audit.
- Appoint a senior executive to own the lease compliance strategy and project execution. Abstracting all the information from a current lease portfolio alone is not something to be taken lightly or easily.
- Form a team spanning key stakeholder departments that is explicitly responsible for the compliance project. It is not just an accounting and finance project; the effort should extend across the entire organization. Procurement needs to be involved, as well as accounts payable, real estate, corporate information technology, operations, logistics and treasury, to name but a few departments. It's important that these departments have clearly defined responsibilities for the compliance project both within their department and the overall team.
- Establish a communication cadence with the external auditors to review the project plan and key conclusions. Engage external auditors and technology partners in the process early on. Make sure they understand the company’s processes and how it’s going to determine the completeness of its lease portfolio. Early involvement and frequent communications can mitigate surprises, which may occur later in the project.
2. Non-real estate leases are the long pole in the tent.
Traditionally, there are some leases that haven't been managed in a system. They're not usually centralized, and that creates some unique challenges. While real estate leases usually have a very clear path, for leases with smaller values, it may not be clear who executed it. Some retailers, for example, find that they have four times the number of non-real estate leases than real estate leases, so they aggregate some of the data together.
One way to look at the non-real estate leases is to think about them as equipment leases, which is likely where the majority of them are—for copiers, laptops and the like. They may not have been put on the balance sheet before, but they now can be classified as leases that need to be considered.
- Inventory asset leases sooner so the data can be recognized as part of the ASC 842 disclosure. Often, this is where the challenges getting the needed data will be encountered, so it’s best to know them early.
- Short-term leases will now exist. Organizations will need to develop a dollar threshold rather than a duration threshold to book deferred rent, as many of them will be material.
- Sale leaseback transactions may be considered. With leases now on the balance sheet, these transactions may be considered again by the Treasury department.
3. Practical expedients’ decisions affect data requirements and abstraction.
There’s a balancing act that companies go through as management determines their options regarding the financial impact of various leasing issues. Items such as gross rent leases, tenant allowance, impaired leases, and leases with purchase options or terminations, for example, must be examined with an eye toward documenting that full lease population for the organization in a fairly robust fashion.
Have a plan for which practical expedients will be adopted by your organization, and involve the appropriate management as this could require additional data to be gathered. To support practical expedients as well as other information (such as interest rates), data will need to be provided from another outside-the-system source. This needs to be understood and gathered, as necessary.
Engaging an external auditor in the process, although not required, is definitely easier and can eliminate many surprises as the team goes through the process.
- Develop a plan to determine which expedients will be adopted by the organization and require additional data.
- Documentation of a company’s procedures over completeness of its lease population should be robust and in a format to be shared with an external auditor.
- The materiality of impact will help drive the correct decisions for the organization.
4. Getting the data puzzle right is everything.
As noted in Accounting Today, complicated lease contracts can have up to 75 different data points; multiply that by 2,000 leases and a company quickly has a cache of data that will not work on spreadsheets. Unfortunately, many companies are collecting data for leases manually.1 Given the amount of data to collect for compliance, this can be a labor-intensive effort.
Not all the data are going to be on the lease. Companies are going to have to look off lease to get about a third of the data required to meet the 842 standard. Decisions about the common data elements (i.e., off-lease information) should be decided before working with the leases. With proper upfront planning, this can reduce the number of times a lease is touched, thereby reducing the effort in the lease-information collection.
But the data collection process is really never over. The portfolio is going to have some leases that expire, some new leases and some addendums. Making sure that processes are in place to continually update and refine lease information is critical. It is also important to make sure it's clear who has signing authority and how these processes are going to be managed.
- Avoid the second pass of data collection. Ensure you understand your data requirements at the outset.
- As only two-thirds of data required will be contained within master lease agreements, companies need to go off lease to gather specific data.
- The data collection process is ongoing. Plan for continual review of leases and check modifications, reassessments and renewals.
5. Plan on integration scope creep.
The bulk of preparing for adoption of this lease accounting standard is taking the information that's being managed in the lease tool and transmitting it into the general ledger. The key is to have an idea up front of what postings management is looking to run through that system. For example, are initial assets being put on the books through an initial posting or is that something being done through a manual process?
It’s important to understand the intended integration between the lease accounting solution and a company’s enterprise resource planning system(s). For example, does it involve opening entries, closing entries or impairments? All of the integration requirements should be designed from a business level from the start to clarify what would be expected of the system. Aggregation (summary versus detail, postings by company, postings by lease and the like) is an important consideration and would need to be aligned to how data is captured in the system.
Companies that have a more diversified portfolio of applications and multiple potential ERP systems might have a little bit more work to do in this area. But starting out with an understanding of which systems are being integrated—as well as the requirements and the time needed for implementation—is critical to staying on track.
- Produce a detailed integration design blueprint.
- Determine the scope of integration with your general ledger.
- All integration requirements should be designed from the outset at a business level in order to clarify what is expected of the system.
6. Testing or painting the plane while flying.
After data is collected and integrations built, testing typically becomes the focus of compliance projects to ensure the information is accurate and complete. Plan how and where testing will occur. The process of testing 842 schedules often involves updates to data along the way.
So it’s important to be clear regarding what is going to be measured and how it's going to be measured. Testing is not just about validating results; it also helps to assess what steps need to be followed and the impact this has on the process and day-to-day operations.
So whether a company is using a commercial package designed for ASC 842 compliance or using a spreadsheet software, testing is needed to ensure the company is disclosing accurate information on its financial statements. Typically, two rounds of user acceptance testing are required to get accurate results.
- Some requirements only apply to ASC 842 or ASC 840. Understand how differences will be supported so the transition will be quick and painless.
- Conduct one or more dry runs of the cutover to ASC 842. Test the system, data and reporting impact of the transition.
- Leverage a staging or transition environment to mitigate extra work and keep data aligned.
7. Have a detailed transition plan and timeline.
Compliance with ASC 842 is not a one and done effort. The transition itself needs to be highly scripted to expedite the approach. “Turning on” 842/IFRS 16 while turning off 840/IAS 17 will need to be automated in order to support a transition in a timely fashion. Decisions regarding whether to keep or decommission related financial bookings (such as tenant allowance and favorable/unfavorable leases) need to be considered as well.
After the transition, the procedures and governance need to be in place to keep the data current and make sure that the lease portfolio itself stays current, year over year. The best way to monitor the project’s status and ensure the implementation is progressing is to have a detailed plan with key milestones, assigned responsibilities and, to set expectations, preliminary numbers.
- Factor in a four- to six-month period to complete the transition to ASC 842. Implementation is not an overnight process.
- Conducting a dry run is the most effective testing methodology to ensure clarity about the transition’s moving parts.
- Develop a communication plan for the organization to ensure consistent timing of implementation and balance sheet impact.
This summary of best practices was based on a webcast developed with Bart Waldeck and Rick Zelinsky of Tango Analytics.