New Lease Accounting – The State of Implementation

The adoption “deadlines” for IFRS 16 and ASC 842 have now passed and while there was no seismic movement across the globe on 1^st January 2019, nonetheless, financial reports for periods post the implementation deadline will resound with the impact of the trillions of dollars’ worth of operating lease commitments now appear on balance sheets across the world.

A Qucik Recap:

In February 2016, The International Accounting Standards Board (IASB), in conjunction with the FASB (which itself issued ASC 842), published an Accounting Standard to replace IAS 17 with the intention of improving on adoption of the standard and financial reporting of lease transactions by lessees. This implementation would result in improved transparency of assets employed by companies along with the associated financial obligations and would be achieved by the requirement to follow more specific directives under IFRS 16 as opposed to an interpretation of the guidelines under IAS 17.

“The new guidance responds to requests from investors and other financial statement users for a more faithful representation of an organization’s leasing activities,” stated FASB Chair Russell G. Golden. It ends what the U.S. Securities and Exchange Commission and other stakeholders have identified as one of the largest forms of off-balance sheet accounting, while requiring more disclosures related to leasing transactions.

Throughout the project by FASB and IASB, interested parties were consulted, briefed and involved particularly with regard to the role and impact of Lease Finance and the Financial implications of the changes proposed under ASC 842 and IFRS 16”.

What is the Current State of Play?

In a recent survey, conducted in October 2018, there was some evidence of progress since a similar snapshot was taken in Q2, but the overall message was that “much work remains to be done”. Whilst all those surveyed intended to adopt ASC 842 they divided into two categories – Public Companies and Non-Public Companies. This division is significant in that Public Companies were not only way ahead in Q2 but continued to make real progress through to Q4. The latter group though have continued to lag way behind. Those polled were asked to evaluate their progress as being in one of the four phases below –

1. “Have Not Started”
2. “Assessing the Impact”
3. “Implementation in Progress”
4. “Implementation Complete”

Who Responded?

• 450 Companies
• 91% of the companies were US GAAP reporters
• 58% had a turnover of $1billion or more
• Public Companies represented 72% of the sample

What is the Evidence from the Public Company Respondents?

Disappointingly less 5% of public company respondents had transitioned completely to ASC 842, meaning though more than 95% have still to complete implementation, encouragingly 76% were in the “implementation” phase.

Where were the rest of this category? – well 3% declared that they had still to start!

Interestingly 75% of the public companies surveyed were either planning to adopt a “new lease management system” (58%) or to modify their existing lease management system. Despite the fundamental change represented by the transition of the existing lease portfolio and the revised treatment of new leases going ahead 22% of Public Companies were planning to continue to manage the load with spreadsheets or other desktop applications and that seems to fly in the face of the  $500,000+ being predicted (by 75% those polled) as the incremental cost of placing 1,000+ leases under the new standard ASC 842 – and nearly 10% predicted more than $3million.

What are the Non-Public Companies Regarding Adoption?

Although 2% have completed the transition to ASC 842 an incredible 28% have yet to START meaning that 63% of those polled had not yet completed even the “Assessing the Impact” stage. Though this is an improvement on Q2 it does reflect the apparent difference in urgency compared to that displayed by the Public Companies which is again evidenced in the cost assessment of this category were 58% of those with 1,000+ leases expected an incremental cost of less than $500,000. 

Spreadsheet type solutions (53%) lead the way with this category of company whilst a third of companies were looking to a “new leases management system”.

What Factors are Holding Companies Back?

• Are the “new lease management systems” ready? Is functionality there?
• Lack of internal resource – skilled people and lack of budget
• “We’ll miss the deadline anyway” attitude
• Data migration challenges

What are the Challenges to Complete Implementation?

• Ensuring completeness of lease population – 78%
• Identifying embedded lease – 72%
• Data collection, collation and validation – 69%
• Human and capital resource – 66%

Summary

The warning bells have been sounding since the publication of the new standards in 2016 but in fairness there have been other accounting standards to implement and over worked and under resourced finance departments are not shying away from the work so much as prioritising the work load.

Implementation is a big challenge. An overwhelming majority (87%) of companies surveyed said adopting recent accounting changes (including the revenue recognition and lease accounting standards) has been somewhat or very difficult.

Public companies are making progress. The survey showed that while just 4% of public companies had completed implementation, 80% have their implementation in progress but Non-public companies, which have an extra year to implement the standard, are more evenly split between implementation in progress (35%), assessing the impact (35%), and have not started (28%).

Testing is an important step. Many public companies are going through an important late-implementation exercise of testing their systems, according to Sheri Wyatt, CPA, a partner with PwC’s Accounting Advisory practice. A third-party solution such as LOIS Lease Accounting will allow “impact testing” as well as verification testing.

Systems decisions have varied. Software solutions do exist and can be priced such that the benefits and ease of implementation far outweigh the costs. Cloud based solutions mean no issues with in house systems integrity.

Process improvements are possible. Throw the spreadsheets away! Although, many companies are rushing to get into compliance, improvements in accounting processes also are being made. “Public companies view this as an opportunity to enhance and streamline their lease accounting process that to date has been largely manual through spreadsheets,” Wyatt said. “[They are] trying to identify some efficiencies as well as just better controls around that process, and so the system is a great tool [for companies].”

Operational benefits may be explored. Now a company knows the assets and liabilities it has on various leases with various lessors can it leverage these to reduce costs on the existing as well as future portfolio.

Private companies can learn from public companies. Wyatt said some of her public company clients that don’t have calendar-year reporting schedules are learning from the calendar-year companies. She said private companies also should pay attention to the implementation challenges faced by public companies. “Yes, you have an additional year,” she said. “But don’t underestimate the effort and that you would benefit from that extra year to make sure you don’t have some of the hiccups that maybe some of our public companies may be facing now.”

The scope and difficulty of the work (identified by those surveyed) and the dearth of skilled resource and available budget point to a third party solution – speak with your auditors or better still a specialist consultancy and lease accounting solutions provider such as ourselves here at www.innervision.co.uk

Where can I find Guidance on Transitioning to IFRS 16 and ASC 842?

For further guidance on implementing the new lease accounting standards we have put together this inclusive guide to transitioning to the new standards – IFRS 16 or FASB ASC 842. Just follow the link below to access the guide.

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Disclaimer: this article contains general information about the new lease accounting standards only and should NOT be viewed in any way as professional advice or service. The Publisher will not be responsible for any losses or damages of any kind incurred by the reader whether directly or indirectly arising from the use of the information found within this article.