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Companies launch year-end push to new lease rules

Tammy Whitehouse | October 16, 2018

The fourth-quarter dash to new lease accounting rules is on, and it’s becoming clear some companies will not finish their preparations in time to flip the switch to new systems by the Jan. 1, 2019, effective date.

“It is only a quarter out, but because you don’t have to report until the end of the first quarter, many are thinking they still have two quarters to work on this,” says Angela Newell, national assurance partner at BDO USA. “We still see a lot that are not as far in the process as they had hoped or wanted to be.”

Readiness spans a wide spectrum, says Joseph Brown, national managing partner at Grant Thornton. “We’re seeing everything from companies that are now in software and testing output to those in their ‘oops’ moment realizing they put this off way too long,” he says. That last group is getting smaller, he says, but “after the first of the year, absolutely, there will be a lot of companies actively working on this in the first quarter.”

Accounting Standards Codification Topic 842 on lease accounting requires companies to elevate their lease-related assets and liabilities out of footnote disclosures and into the financial statements for the first time beginning in 2019. That means calendar-year companies will begin reflecting leases on their balance sheets in their first-quarter filings.

Leading up to that massive change in accounting, which is broadly expected to bulk up corporate balance sheets by trillions of dollars, companies are expected to give investors some forewarning about how their financial statements will look when they adopt the new accounting. That’s the requirement under the Securities and Exchange Commission’s Staff Accounting Bulletin No. 74, which the SEC has been reminding companies requires incrementally more disclosure as they approach the effective date of a major accounting change, like revenue recognition at the beginning of 2018.

Newell says it’s not unreasonable for companies to continue working on their adoption activities into the new year, but they will face some significant scrutiny if they arrive at the end of 2018 and can’t provide more detail about how their financial statements will be affected. “It may raise red flags about the control structure,” she says.

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Hal Hunt, managing director at CBIZ & Mayer Hoffman McCann, says companies can expect auditors and the SEC to call for incrementally more disclosure in third-quarter and year-end filings. “If you continue saying you’re looking into it, you could draw some questions,” he says.

That’s not to suggest every company is operating as if in a fire drill. Plenty of companies have been focused on transitioning to the new requirements for months or years, says Anastasia Economos, a partner at EY and the firm’s Americas accounting change leader for leases. Yet, many of those companies are still encountering implementation challenges as they arrive near the finish line.

Many companies that are further along in the process are performing user acceptance on their lease software, says Economos. “Do the calculations produce the answers you expected?” she says. They’re testing workflow, notifications, and calculations to see if the software works as intended, and therefore can be relied on to produce data reported in financial statements. “Some are still finding challenges that have to be worked out,” she says.

Companies are also determining what they need to do to establish the cumulative effect adjustments they will book on day one to transition the financial statements to the new accounting. They are encountering various “one-off” scenarios, she says, like build-to-suit or sale-leaseback arrangements, where the numbers may not be set in stone until the transition date. “It’s accountants that have to figure that out, get the data, and book the en      try,” she says.

Another issue producing significant end-of-implementation activity, says Economos, is the determination of incremental borrowing rates. ASC 842 requires companies to use the implicit rate in a lease contract as the discount rate for calculating the lease liability, which means it’s a critical input to the calculation of figures that will appear in financial statements. Where rates are not readily determinable, companies must rely on their own incremental borrowing rate, or the rate the company would pay if it had to borrow on a collateralized or secured basis.

That raises some factors to consider, says Economos, and it’s leading to a lot of research. Corporate borrowing rates may not be the same as rates to finance a specific leased asset. Answers may differ depending on whether a company’s borrowing function is centralized or decentralized, whether there are foreign jurisdictions and foreign currencies to consider, and what kinds of adjustments need to be made for either secured or unsecured rates. “There are nuances that have to be reflected in whatever model the company selects,” says.

Sean Torr, managing director at Deloitte, says he sees companies taking a number of different approaches to identifying their incremental borrowing rate. “The key here is understanding the drivers of the incremental borrowing rate relative to the lease portfolio,” he says. “It requires input from folks outside the accounting group,” like treasury, lenders, and external market data sources.

The key to identifying appropriate rates, says Chris Wright, managing director at consulting firm Protiviti, is to follow a sound process and document it fully for auditors. Understanding the payment for a particular lease and its life are important precursors to determining a rate, he says. “Companies that have gotten the process in the right order have had an easier time of it,” he says.

Similarly, companies that are further along in their preparations tend to be those that began with a multidisciplinary approach and carefully defined their needs, says Wright. “They began with a clear view rather than just buying a system because they needed a system,” he says. “They had a clear view of what they wanted to get from the system. Is it just accounting? Or is it integrating accounting with payments, or integrating accounting with property management?”

At Grant Thornton, Brown says he’s anticipating an “awakening” that will occur after the first of the year regarding the differences companies will need to identify and address for tax purposes between their accounting books and their tax records. Accounting rules and tax rules are different so companies are going to have to adjust their tax records to reflect new accounting entries.

“All of the new accounting is going into software that doesn’t currently accommodate the difference from the book and tax perspective,” says Brown. That’s another issue companies that are further along in their implementation activities are just beginning to contemplate, he says.

In addition, says Torr, those companies on the leading end of implementation are giving more thought to what the recurring operating model looks like heading into 2019. “Many companies have used external forces to get ready for the systems and the data, but now they’re thinking about the go-forward business as usual,” he says. Depending on the company, that might include discussions about further integration of systems, automation, and other uses of the new information companies are now assembling, he says.

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