With a final heave-ho to get leases on to corporate balance sheets, public companies generally are expected to be ready for year-end reporting but still face some added work to prepare for the ongoing accounting.
“People are pretty fatigued,” says Sheri Wyatt, a partner at PwC. “It was a big lift for different reasons, but people are starting to feel like they are approaching the finish line.”
Some companies have substantially completed their implementation work around Accounting Standards Codification Topic 842, says Wyatt. “Those may be the exception rather than the rule,” she says. “Most had a big push at year-end so they could provide robust disclosures around what the effect on the financial statements is going to be.”
ASC 842 is the standard that took effect Jan. 1 for calendar-year public companies requiring virtually all lease-related assets and liabilities to be added to corporate balance sheets. Finalized by the Financial Accounting Standards Board in early 2016, ASC 842 provided for a long lead time so it would follow an even bigger change in revenue recognition that took effect a year earlier.
Under Staff Accounting Bulletin No. 74, the Securities and Exchange Commission requires companies to provide investors with advance notice of how a company’s financial statements will be affected by pending new accounting pronouncements. The SEC has generally indicated it expected increasing detail, even quantitative detail, as companies approached the effective date.
“We’re generally seeing most companies are in good shape to make their year-end SAB 74 disclosures and their opening transition adjustment,” says Scott Muir, a partner at KPMG. “We’d generally expect companies to be able to provide some relevant quantitative information in their SAB 74 disclosures about the effects of the new standard.”
Most companies have put their information technology systems into place and have tested them at least at a high level, Muir says, but many will have some work to do in subsequent periods to make their controls and processes sustainable on a go-forward basis. “Many companies will have a longer tail in terms of getting their ongoing processes and controls in place,” he says.
After inventorying their existing leases, abstracting the necessary data, and performing the necessary calculations to implement the standard, companies also need to work out how they will continue to comply in future periods. They need controls and processes, for example, to capture new leases and modifications to existing leases to continue the accounting into subsequent periods.
“We expect companies will continue to work to develop those processes and controls for some period of time, even after they’ve adopted the new standard,” says Muir.
While experts say companies generally are ready at year-end, that doesn’t mean all companies have crossed the finish line. Sean Torr, managing director in risk and financial advisory at Deloitte, says many companies are still dealing with “curveball scenarios,” like how to account for a lease that has unusual payment streams.
“By and large, companies know where they need to get to, but now they just are getting data sanitized and normalized into the system and making sure the system is working the way it’s intended to work,” Torr says. “The level of anxiety around technology aspects is high across the board.”
“By and large, companies know where they need to get to, but now they just are getting data sanitized and normalized into the system and making sure the system is working the way it’s intended to work. The level of anxiety around technology aspects is high across the board.”
Sean Torr, Managing Director, Risk and Financial Advisory, Deloitte
James Barker, senior consultation partner for lease accounting at Deloitte, says he still sees a lot of companies testing their systems, which is likely to raise eyebrows among auditors. “To me, it’s very notable that companies are still doing user acceptance testing for a standard that’s already effective,” he says.
Barker said he expected companies still testing systems late into the fourth quarter might have switched to manual processes as a bridge to compliance on the effective date. “We’re finding many companies haven’t pulled the plug yet,” he says, a fact he finds surprising. “It’s not the best to adopt a standard using a system you haven’t quite finished testing yet. It’s not a great starting point when you talk to your auditors.”
Barker says he also sees companies doing a lot of work to double-check, even triple-check, that they’ve captured their entire population of leases. “They are getting ready to demonstrate to auditors that their list is complete and accurate,” he says.
That has included some 11th-hour work on embedded leases, or lease obligations that might be contained in other contracts, like service agreements, says Wyatt. “Some companies haven’t addressed the full uncertainty yet,” she says. “Some additional work is still under way centering on whether the analysis is complete.”
Companies are also double-checking their abstraction of lease data from lease contracts, assuring they’ve gathered all the right data and have entered it accurately into their lease accounting system, says Barker. “There’s a big effort to make sure that’s finished but also accurate,” he says.
To some extent, some companies are also working on what discount rate they will use to measure and book their lease liabilities. The standard generally requires companies to use a rate that reflects their cost to borrow, but it does not prescribe a method for determining the rate. “The discount rate continues to be one of the top themes we have seen in terms of questions,” says Barker.
Thomas Faineteau, national assurance partner at BDO USA, has heard the questions, and they often surround how to apply the guidance to difficult situations, he says. A long-term lease of land, for example, might have a term of 50 years, making it difficult or impossible to observe a rate in the market with a similar duration. “It’s important for people to discuss things like this among themselves, other companies, and with the accounting firms, so the guidance is applied consistently by everyone,” he says.
Companies have also struggled with identifying appropriate discount rates in entities that involve subsidiaries, especially overseas. “If a lease is entered into by a subsidiary say in the U.K., do I need to get individual discount rates for each of my subsidiaries, or do I look to the overall parent borrowing rate?” asks Wyatt. “That has generated a lot of questions, and there are differences in views.”
Preparers also are considering the impairment analysis that must occur after new assets are added to the balance sheet under ASC 360. The impairment or markdown analysis that must occur for fixed assets is not new, but the application of it to a larger population of leased assets will be new. “It didn’t apply to operating leases historically because operating leases were off balance sheet,” says Barker.
Some companies are even dealing with questions about whether certain leases should be marked down at transition, said Barker. Lease liabilities are calculated based on the present value of remaining lease payments, but that equation can produce a number that is bigger than the fair value of the asset, he says. “We think there are circumstances where there should be impairment testing at the date of adoption,” he says.