Weary from accounting change? Brace for more in 2019

Companies will file their first quarterly reports in 2019, reflecting a massive change to bring leases to corporate balance sheets. They will also stare down a 2020 effective date for a new method for recognizing credit losses, and they may need to revisit work they completed in 2018 to change the way they recognize revenue.

Leases will be the first order of business, as companies comply for the first time with Accounting Standards Codification Topic 842, which requires virtually all leases to be elevated from historic footnote treatment to a prominent place on the balance sheet. The standard took effect Jan. 1 for calendar-year public companies.

While the accounting itself is not that drastically different from historic treatment, the financial statement recognition commands a new level of rigor in identifying and reflecting lease-related assets and liabilities. ASC 842 retained the basic treatment of historic operating and capital leases, but the definition of a lease under the new standard has prompted some companies to dig deeper into their various contracts in search of lease obligations.

The standard requires companies to identify lease arrangements that may be embedded in other contracts, like service contracts, for example. “The hard part is trying to determine in your supply contracts whether there’s an embedded lease,” says Peter Bible, chief risk officer at audit firm EisnerAmper and a former chief accounting officer at General Motors.

For manufacturers, which typically have large numbers of contracts with suppliers, many of those contracts may contain terms that are akin to leases. “It becomes very judgmental to flesh out whether there’s a lease in a supply arrangement,” Bible says.

Companies have also prepared for their first quarterly filings under the new leasing standard using an assortment of technology supplemented by manual workarounds as software vendors have continued to finalize their solutions. That suggests companies will continue to develop and refine their controls and procedures even as they begin reporting under the new standard.

“My biggest fear is banks will use [calls for delay] as an excuse to not start. If you proceed and it’s delayed, you have time to run parallel and refine your model. If you assume it will be delayed and you don’t start, the consequences are really big and bad.”

Mike Lundberg, Partner, RSM

“Q1 is the linchpin,” says Jim Burton, partner-in-charge of audit methodology and standards at Grant Thornton. “That’s when you’re actually recording the effect of adopting the standard. Did it match your expectations as of year-end? Is the company’s process for capturing new leases thorough enough? Are the disclosures provided sufficiently robust?”

The first quarter of 2019 will also be a time of reckoning in terms of the work companies have done to comply with ASC 606 on revenue recognition, which took effect in 2018. The Securities and Exchange Commission has signaled it is looking for companies to make some improvements over the quarterly reporting that occurred throughout 2018.

As such, the coming year will be a time for companies to look back at their compliance with ASC 606 and consider whether they should make changes going forward, says Phillip Austin, national assurance managing partner at audit firm BDO USA. “Companies are being asked: How did you prepare for and adopt the revenue recognition standard?” says Austin. “Why did you choose these disclosures? What did you consider at the time?”

In some cases, companies are asked to produce documentation from e-mail communications and meetings to show what they did and how they reached their determinations, says Austin. “Expect to be questioned in 2019,” he cautions. “Those questions would be high on my mind.”

And then companies will face the next big accounting adoption in 2019—ASC 326 on credit losses, which requires companies to adopt a “current expected credit losses” methodology to estimating and reflecting trouble in their debt-based assets.

“In 2019, it’s all CECL, CECL, CECL,” says Paul Noring, managing director at Navigant Consulting. The new CECL approach to recognizing loan losses is a massive change for financial institutions, but it’s also an important change even for operating companies that may have various forms of credit-based financial instruments on their balance sheets, like accounts receivable or debt securities they plan to hold to maturity.

“It’s a completely different way of looking at the credit portfolio for reserving purposes,” says Noring. “It impacts so many different areas—accounting, modeling, how to talk numbers on the street, planning.”

The largest financial institutions have been developing and refining their CECL models for many months, says Noring. Many of them are planning to run their CECL models side-by-side with their current incurred loss models in 2019 so they can see empirically how CECL will work and how it will affect the business. “The largest banks are well down the route, deploying a tremendous amount of resources,” he says.

Smaller financial institutions may have more work to do to develop or finalize their models, and many of them are turning to outside resources for help, says Noring. “The phone is ringing more,” he says. Operating companies that are not tuned in to the financial services sector may have even more work to do to prepare for the new accounting, although the effect for them will not be as pervasive.

Some in the financial services sector are calling on the Financial Accounting Standards Board and even the U.S. Treasury to delay CECL so its systemic effects on the economy can be further studied. Some are also asking FASB to reconsider the income-statement treatment of CECL. FASB is planning a January roundtable to air the various concerns.

Faye Miller, a partner at audit firm RSM who focuses on financial instruments, says the companies that are furthest along in their CECL preparations have found the process takes more time than they expected. Global entities got an even earlier start with a CECL-like model as they adopted International Financial Reporting Standard 9 on financial instruments.

Banks that were involved in IFRS 9 implementations because of global activity found the process to be more time consuming than they expected, says Miller. “Now we’re hearing banks reporting under the U.S. standard are learning that lesson,” she says. “They wish they had started earlier.”

Companies have encountered problems with acquiring the necessary data, says Mike Lundberg, also a partner at RSM who directs financial institution services. In some cases, companies haven’t retained historic data that would now be useful to comply with CECL, or they retained the data but it was never subject to rigorous internal control, so it’s reliability is suspect. “They need to build controls over the collection and retention of data going forward, and they need to go back and validate data they were able to find,” he says.

The biggest CECL objective of 2019 will be to pick up wherever a given company is in the process and prepare to comply, despite any discussions that may be occurring regarding delay or changes to the model, says Lundberg. “My biggest fear is banks will use [calls for delay] as an excuse to not start,” he says. “If you proceed and it’s delayed, you have time to run parallel and refine your model. If you assume it will be delayed and you don’t start, the consequences are really big and bad.”