In a perfect world, companies would be all over the new lease accounting standard that takes effect in 2019 to assure their financial statements fully and accurately reflect their lease obligations. But indicators suggest companies are slipping behind, and perhaps even mounting a call for a delay in the effective date.
A recent survey by Deloitte says roughly half of C-suite executives are concerned they don’t have enough time to do an adequate implementation. “It’s one thing to implement, but it’s another to have a quality implementation,” says James Barker, a senior consultation partner at Deloitte. “That means getting everything right, not rushing through it, not cutting corners or making sacrifices.”
The Financial Accounting Standards Board adopted the new accounting requirements in early 2016 to tell companies to take inventory of their leases and add them to the balance sheet by 2019. Now companies are beginning to tell the FASB they don’t have enough time. In fact, the American Petroleum Institute has gone on record with the FASB and the Securities and Exchange Commission to formally request a delay in the effective date.
The API letter cites many of the same concerns that accounting experts are seeing as they help guide companies through the implementation. Four key factors are making it difficult for companies.
Factor #1: Technical accounting questions. Companies are finding they have a lot of questions about how to transition to the new guidance, says Eileen Chan, executive director in financial accounting advisory services at EY. “We are seeing sometimes there are different interpretations,” she says.
The standard contains some provisions that were intended to make it easier for companies to transition to the new standard, but they’re not entirely clear, says Chan. The Financial Accounting Standards Board has heard the clamor and has begun addressing questions.
“There’s one paragraph in the standard that addresses transition but it has numerous subparagraphs,” says Rich Stuart, a partner at audit firm RSM. “Depending on what position you’re coming from, there are a number of potential items that can trip you up in transition. With any guidance of this magnitude, there are going to be questions that pop up after issuance.”
Deloitte asked companies how concerned they are with their ability to implement the new lease accounting standard by the chosen required date.
The board determined recently it will make a change to the transition provisions to give companies a practical expedient. It is expected to say that in cases where companies have land easements or rights to use land that are not currently accounted for as leases, they will not be required to treat them as leases under the new standard.
That may help companies that are interpreting the technical requirements to potentially apply to obscure obligations that have not been considered leases in the past. The classic example is a right to post advertising signs or billboards on the exterior of buildings that the company does not otherwise lease.
In part, the fact that technical questions are surfacing is an indicator that companies are digging into the details and thinking about how it will affect their particular transactions, and that’s a good thing. “Part of it is people didn’t look at it early enough,” says Stuart. “Now they’re saying this isn’t as clear as we thought.”
Factor #2: Revenue recognition. It’s through “no fault of their own” says Stuart, that companies may have taken some time before they cracked the spine on the new leasing standards. Companies have their hands full right now adopting even bigger new accounting requirements around when and in what amounts to recognize revenue in financial statements. That massive new standard takes effect in 2018, and experts say companies spent too long dragging their feet and studying how they will be affected before developing the processes and controls necessary to comply.
“Revenue recognition is less than six months away, and it is in many ways has more of a P&L impact associated with it,” says Paul Noring, managing director at Navigant Consulting. “It’s potentially changing how people recognize revenue and ultimately net income. The leasing standard is probably going to change the balance sheet more than net income. It is in some ways a bit more profound.”
Factor #3: Data collection. Revenue recognition aside, experts says many companies underestimated the amount of work it would take to find all of their leases that might be scattered throughout the organization, bring them into a centralized repository, then gather the data necessary from each lease to perform the required calculations.
“Every company is organized and structured differently, and they have different controls,” says Noring. “They may have people entering into leases all over the company. Trying to corral and identify all those leases is bit of a hunting and pecking exercise. There’s a lot of looking under rocks.”
Chris Stephenson, business consulting and technology principal at Grant Thornton, says the firm has estimated each lease contains 30 to 35 data points that must be gathered and analyzed to determine all the appropriate accounting. Things like timing, payment, classification, location, future cash flow and numerous other aspects of the lease must be studied and considered.
“If you thought of your lease population as a spreadsheet, with every row a lease and every column a data point, companies are missing both rows and columns,” says Stephenson. “There are leases they don’t know about, and there are entire data sets that haven’t been collected historically. It’s not technically the hardest part, but it’s time consuming.”
“We’re seeing in recent studies many companies have started to prepare, but some still have not yet started. Those are the ones that are more concerning. You really need to start. If you haven’t, you don’t have too much more time to procrastinate.”
Eileen Chan, Executive Director, EY
Factor #4: Software. Software vendors have followed the standard and developed solutions, but there’s no single package yet that addresses every aspect of the standard for any given company’s needs. “There are a number of products that get you a high percentage of the way there, but we’ve not yet identified one that gets you 100 percent of the way there,” says Stuart.
Some solutions are focused on real estate leases, some on equipment leases, some for the requirements under U.S. GAAP and others for the rules that are a little different under International Financial Reporting Standards. “We haven’t identified a silver bullet,” says Stuart.
It’s an evolving, maturing process, says Chan, and companies are working in the meantime to develop their own additional processes outside of their chosen software. “To the extent certain functionalities are not in the system, they are having to supplement manually.”
Ultimately, there’s plenty of functionality in the marketplace for companies to adopt the standard, but companies need to be on top of developing whatever supplemental procedures they’ll need to comply, Chan says. Barker says vendors are running at full tilt to try to meet the market demand for software installations and upgrades, so companies would be wise to get in the vendor queue to assure they are not shut out by any resource constraints that may be developing.
While the petroleum group is the only one so far to publicly and formally request a deferral in the effective date, Barker says the idea may start to gain some momentum with others who may make similar appeals. “As companies come to a realization they are behind the eight ball, they are going to start to putting pressure to potentially seek deferral.”