Companies are at a pivotal point in their lease accounting journey, based on results from the latest annual survey by EY and LeaseAccelerator.
Effective dates of Accounting Standards Codification (ASC) Topic 842 and Governmental Accounting Standards Board (GASB) Statement No. 87 have arrived, and organizations in all industries must develop and implement compliance plans for adoption and beyond.
The “2022 Global Lease Accounting Survey” includes responses from U.S. private and public organizations. It covers how they address U.S. and international accounting requirements, processes they use, and challenges they have had and expect to face post-implementation.
U.S. public companies and international companies applying ASC 842 and International Financial Reporting Standards (IFRS) 16 have already adopted the standards, but most private companies have not. There is no “one-size-fits-all” approach, but private companies can apply lessons learned from public companies.
“When public companies started their implementation, the guidance had just come out and there were no mature lease accounting systems or processes in place, but three years later processes are being optimized and systems are more mature,” said PJ Alper, managing director and managed services leader at EY. “Implementation timelines have shortened because there are knowledgeable consultants, templates, and industry thought leadership.”
However, Alper notes challenges are still there for both public and private companies.
Implementation status and integration
Of U.S. private companies responding to the survey, 20 percent are starting lease accounting implementation, while 32 percent adopted early—eight times more than last year.
Decision-making over leases is not centralized and automated for most of the 37 percent of respondents with more than 250 leases, the survey noted.
Surprisingly, 38 percent of respondents continue to use spreadsheets for lease accounting, despite the manual effort and lack of an audit trail.
“We’ve learned over time that for companies with more than ten leases, spreadsheets are not a path they should be choosing because they’re difficult to manage, don’t have required controls, and are very risky,” said Janet Sifers, vice president of product marketing at LeaseAccelerator.
“Given the complexity of the accounting rules, we recommend using a system from a controls and accuracy perspective for public or private companies that have more than 10-20 leases,” Alper agreed.
For 48 percent of respondents, lease accounting is not fully integrated with the monthly close process and other systems, which causes missed opportunities. Inefficient processes can increase the potential for errors, additional work, and higher risk.
“We see a trend in the market right now that public companies are refining, optimizing, or switching systems,” Alper said. “Since 2017, technology has advanced, and many companies are learning the systems selected did not have the right functionality and are migrating to new systems or are being forced to change because of systems being decommissioned.”
She noted there are multiple technologies available, including some specific to industry or type of lease, and companies should evaluate which is right for them depending on the complexity of their lease portfolio and their enterprise resource planning system.
The top three audit challenges noted in the survey were completeness of the lease population (32 percent), recording ongoing out-of-period adjustments (30 percent), and timely lease capture (28 percent).
“Before ASC 842, everything was done manually and lease documents were in people’s desk drawers, so it is challenging to find them all and centralize the process. We suggest our clients educate the nonaccountants in their organizations entering into these contracts about what a ‘lease’ is for accounting purposes, so they know what information to provide.”
PJ Alper, Managing Director and Managed Services Leader, EY
Completeness and identifying agreements that are, or contain, a lease for accounting purposes is an area where EY frequently gets requests for help from private companies, said Alper.
“Before ASC 842, everything was done manually and lease documents were in people’s desk drawers, so it is challenging to find them all and centralize the process,” Alper said. “We suggest our clients educate the nonaccountants in their organizations entering into these contracts about what a ‘lease’ is for accounting purposes, so they know what information to provide.
“It’s normal for companies to have out-of-period implementation adjustments, which in our experience are mostly data-related or because of reporting time lags. Starting in 2017, companies did their best to gather lease data and have it be materially accurate. But incomplete data and normal human error when implementing new guidance required adjustments.”
Added Sifers, “We’ve found companies with a decentralized leasing model, especially with equipment leases, are likely to discover they have an asset out of commission where something happened to it in a previous period that’s not discovered until after the close.”
Post-adoption, public companies have ongoing challenges complying with the accounting requirements over the life of all leases, along with internal control enhancements and process improvements. Survey respondents noted lease accounting integration and governance lag other finance functions.
Key internal control challenges in the survey results included capturing all leases timely and reconciling terms in lease agreements to the lease system, validating completeness of the lease population over time, and handling lease change events (e.g., modifications, adjustments, and impairments).
Personnel issues, including team fatigue and employee turnover, affect lease implementation. Alper noted the “Great Resignation” because of Covid-19 led to a lack of resources with the right knowledge.
Only 41 percent of respondents had a dedicated lease accounting team (35 percent have three to five full-time equivalents), and 24 percent said there was team fatigue. For U.S. private companies surveyed, only 9 percent reported team stress, reflecting their early stages of implementation.
Despite this result, 86 percent of overall respondents were not planning to change team size. Instead, they will obtain additional outside resources, make process improvements, and/or increase automation and third-party services. Most respondents (51 percent) are outsourcing to manage services.
“Lease accounting is complex, and it can be very time-consuming to track all the lease details and consistently get the right accounting every reporting period,” Alper said.
Return on investment
The survey pointed out lack of centralization, automation, and system integration make it more difficult to achieve strategic benefits and return on investment (ROI) from leasing.
Of all respondents, 70 percent use lease accounting software for accounting and compliance, while only 6 percent have an end-to-end solution for lease management from inception to end of life.
Of public companies surveyed, only 59 percent use lease accounting software.
Regarding ROI from lease accounting software, 32 percent did not see it, 20 percent did, and 48 percent were not sure.
“At certain organizations, lease accounting can be a way for accounting to begin a financial transformation process and drive ROI from within,” Sifers said.
“We have clients that reduced expenses and increased ROI during lease system implementation as a result of cleaning up their lease portfolio and identifying leased assets not in use,” Alper said.
“We were surprised 40 percent surveyed said they return less than 70 percent of their leases on time,” Sifers said. “You don’t get the financial benefit of leasing if you don’t do what you said you were going to do with that lease.”
As companies evaluate lease accounting processes and resources, the report recommends the following:
- At the beginning of implementation, define resources required and create a budget to support lease accounting compliance on an ongoing basis.
- Determine whether lease accounting is key to core operations and whether to retain lease process knowledge in house or outsource it.
To optimize lease accounting and reduce challenges, companies should:
- Leave adequate time to identify all agreements that may be “leases” and to obtain key data required from lease contracts.
- Understand accounting policy elections and the lease data required.
- Identify and design the overall process and internal controls, including resources and skills needed.
“Many of the challenges for private companies today are the same as they were in 2017 because there is still the need to gather leases, identify key data fields, and design process flows, “Alper said. She encouraged private companies not to start from scratch in their lease implementation process and controls but to speak to their auditors, consultants, and others in their industries.