Under ASC Topic 842, Leases, (ASC 842) a lease is a contract, or part of a contract that conveys the right to control the use of identified property, plant or equipment (i.e., an identified asset) for a period of time in exchange for consideration. Most contracts that are determined to be or contain a lease will now be recognized on the balance sheet. Calendar year-end public business entities were required to adopt ASC 842 on Jan. 1, 2019.
As part of the implementation of this new standard, there were a number of lessons learned, of which key ones are highlighted below:
Do not grandfather errors:
Contracts in the past have not received as much scrutiny as they will receive under ASC 842 due to the fact that the recognition of operating leases and service contracts were similar, and operating leases were not recognized on the balance sheet under ASC Topic 840 (ASC 840), Leases. Therefore, errors could have occurred that may not have been material under ASC 840, but may affect ASC 842 accounting going forward. For example, service arrangements that could have been or contained a lease under ASC 840 may not have been assessed as such, and thus, company leaders may not recognize this as a lease during the transition to ASC 842.
Lesson learned:
ASC 842 transition accounting does not allow for the carry-over of incorrect accounting under ASC 840. As a result, prior to adoption of ASC 842, management should ensure they have correctly applied the provisions of ASC 840, especially evaluation of contracts that are or contain a lease. If management identifies any historical errors in the application of ASC 840, they will need to evaluate the materiality of the impact of the errors on its consolidated financial statements, including disclosures.
Select lease accounting and management system:
Company leaders may have previously maintained a decentralized leasing operation and relied on their business units to provide the information needed for lease accounting and disclosures in the financial statements. The information maintained by the business units has generally been limited in nature, especially those relating to non-real estate leases. Going forward, management will require significantly more information than the business units have gathered and provided in the past, and therefore, may require a new system to track and maintain lease operations.
Lessons learned:
- With the additional requirements of the new lease standard, management should identify whether they have the appropriate lease accounting and management system (i.e., either using Excel or a lease technology solution) to handle this requirement.
- Management should take into consideration (among other considerations) the size of their lease population, complexity of the lease calculations and disclosures, the centralization or lack of centralization of their lease environment, the skill set of their resource, whether leases are transacted in multiple currencies, and any local statutory requirements (e.g., reporting under International Financial Reporting Standards) etc.
- Management of companies with a smaller lease portfolio may not need to select a lease accounting and management system; however, they would still be required to track and maintain the necessary accounting information required for compliance and to meet the significantly expanded disclosures with the new standard.
- Management should ensure that the lease accounting and management system selected is able to handle Day Two accounting and ensure compliance with the new standard.
- Other than companies with very small, noncomplex lease portfolio, company leaders have noted that they need a supplemental lease system to ensure the appropriate recordings of the required lease data, initial and ongoing accounting requirements and adjustments, and disclosure requirements are met.
Identify stakeholders:
Implementing the new standard requires different stakeholders within the organization to be involved in the decision-making process, or in the day-to-day implementation activities. Lack of involvement by these stakeholders has led to delays in decisions being made, or incorrect decisions being made that have had to be corrected later, thus leading to more costs and delays.
Lessons learned:
- Management will need to identify the stakeholders affected by the new lease standard, and ensure that these stakeholders are actively involved in the implementation of the new standard.
- The stakeholders who should be included, at a minimum, are: corporate accounting (for accounting and financial reporting, to lead the engagement), real estate or facilities management (for real estate leases), information technology (for system selection and service arrangement exercise identification), procurement (evaluation of lease versus buy decisions, and reassessing procurement and approval policies will facilitate the collection and standardization of lease data for reporting), treasury (consideration of debt covenant compliance, especially as new debt agreements are renegotiated prior to the effective date, as well as, weighing in on the lease versus buy analysis), legal and auditors (share implementation and transition plans with external auditors to avoid surprises during the first audit following ASC 842 adoptions).
- Management should also ensure that there is appropriate involvement from senior leadership; lack of leadership involvement has led to lack of interest from resources within the organization, thus leading to delays in the implementation.
Set up project management office (PMO):
- The implementation of the new standard may require the involvement of multiple stakeholders as noted above, as well as, the implementation of new technology (for some entities) and interaction with international resources (for multinational entities).
- Leaders of companies that do not have clear communication lines, have complex organizational structures, operate in multiple locations or are decentralized tend to struggle with managing the different aspects of the implementation as they are unable to track the progress, the outstanding tasks or what needs to be performed.
Lessons learned:
Company leaders should establish a PMO to help facilitate all the different aspects of the implementation; ensure that stakeholders are held accountable; and that proper communication is shared with all stakeholders to guarantee both successful and timely implementation of ASC 842.
Determine lease population:
- The leaders of many companies have a good handle over their real estate leases; however, the same cannot be said of the non-real estate leases. These leaders are realizing that their non-real estate leases are varied and, in some cases, they either do not have agreements for these leases, or the leases are expired they are still paying on them.
- Furthermore, management is not aware of where all the leases are, and who within their organization has leases; this is leading to delays during the abstraction process and the ability for potential implementation vendors to quote the company fees.
- Identifying the correct lease population has multiple upsides, e.g., management can track the status of their abstraction process, make decisions on the type of lease management system to use, etc.
Lessons learned:
- Management should develop a process to identify their complete lease population, including any potential embedded leases and finalize that process early in the implementation.
- At a minimum, management should perform the following:
- Review general ledger (GL) expense account(s) and cash disbursement register(s) to identify any recurring charges that may relate to a lease agreement.
- Reconcile leased asset (within fixed asset register) to the capital lease footnote disclosure in the financial statements.
- Perform a walk-through of the offices and locations identifying assets that exist.
- Facilitate discussions with your procurement team and others in the organization that have the authority to enter into leases or agreements that may be leases.
- Review vendor listing to identify vendors with recurring fees; for those vendors with recurring fees, ensure you understand the relationship the company has with these vendors in order to ensure that they do not potentially relate to lessors or service entities providing the right for the company to control the use of an identified asset.
- At a minimum, management should perform the following:
Begin abstraction early:
- The abstraction process is generally the longest and most expensive aspect of the lease implementation. Usually, management has not developed a robust plan needed to help guide the abstraction process.
- Management has also not determined the necessary lease data required for abstraction. Is data needed for lease accounting only, or will management want to use the data for lease administration as well? Without answering these questions, the leaders may be abstracting more data than they need.
- The abstraction process is further complicated when leases are located in multiple locations, are in multiple languages, are not in an electronic format, and the total population has not been determined.
Lessons learned:
- Management should develop an abstraction plan upfront, identify where all the leases are located, determine how the lease agreements will be collected for abstraction purposes, determine all the necessary data required for abstraction (data that would be used in the transition from ASC 840 to ASC 842), identify resources to perform the abstraction, and set deadlines as to when critical deliverables need to be met in order to ensure a successful abstraction process.
- Early on, management should identify local resources that can read leases in the local languages, or partner with a vendor to assist with the abstraction of leases in multiple languages.
Elect practical expedients and accounting policies:
Management has not contemplated the practical expedients and accounting policies available to them, and as such, the decisions being made during the abstraction process may not be the most advantageous to the company.
Lessons learned:
- By electing the practical expedients and accounting policies upfront, management will be able to reduce the level of effort required to transition from current generally accepted accounting principles (GAAP) to future GAAP (e.g., By electing the package of three practical expedients, management will not have to reassess the lease conclusions they have reached under current GAAP).
- These practical expedients include:
Practical expedient |
Elections public filers have adopted and why |
Relief package allowing company leaders to not reassess whether a contract is or contains a lease, lease classification, and whether initial direct costs should be capitalized |
Elected—reduces the level of effort and costs of implementation. |
Use of hindsight in determining lease term and impairment of right-of-use assets |
Do not elect—the cost of performing this exercise across the population of leases does not outweigh the benefit. |
Cumulative transition approach to recognize ASC 842 requirements on the effective date, and recognize any adjustment from transition as an adjustment to retained earnings |
Elected—reduces the level of effort as respondents do not have to restate comparative periods. |
Elect the short-term lease exemption for leases less than 12-months |
Elected—reduces the level of effort and costs. |
Elect not to separate lease and nonlease components (for both lessees and lessors) |
Elected—reduces the level of effort and costs as management does not have to determine the stand-alone relative selling prices for the nonlease components of the agreement; however, they still need to determine stand-alone prices for all lease components. |
Apply portfolio approach to leases with similar characteristics |
Do not elect—the cost to track and monitor leases within a portfolio does not outweigh the benefit; and most lease technology solutions require leases to be entered at an asset level. |
Elect to use the risk-free rate as the discount rate (for private companies) |
N/A—this policy is not available to public filers, however, anticipate a large number of private companies will elect. |
Disclosures:
- Company leaders are finding out that due to the late start of implementing the new lease standard, and with the amount of work needed to finalize the implementation, they are struggling to obtain, in a timely manner, the information required for disclosures under the new standard.
- Company leaders have also noted that they have to create new GL accounts to ensure proper capture of information needed for certain new disclosures, e.g., short-term leases and variable lease payment GL accounts to track these expenses in the footnote disclosures, etc. (Most of the lease technology solutions allow for users to track the amounts necessary for the right-of-use assets and lease liabilities in the solutions; however, they do not track all GL accounts.
Lessons learned:
- Management should develop the future state financial reporting process necessary to comply with the disclosure requirements of the new standard
- Management should test the new future state financial reporting process to ensure it is working appropriately and is able to provide the necessary data needed to comply with the new standard.
Private companies can learn a tremendous amount from those who have gone through implementations before them. Given the complexity implementations typically pose, it is important to get started now.
