Governmental lease accounting: 10 mistakes to avoid

October 31, 2019 3:32 PM

GASB headquarters in Norwalk, Connecticut

Courtesy of GASB

It’s hard to believe more than two years have passed since the Governmental Accounting Standards Board issued its long-awaited revision to governmental lease accounting.

GASB Statement 87 transforms the rules that govern accounting for nearly all types of leases, including real estate, vehicle and equipment. For most government entities, compliance means changing their entire approach to lease accounting and financial reporting.

When Statement 87 goes into effect for reporting periods after Dec. 15, 2019, government entities will no longer be able to treat operating leases as a period rent expense. Instead, entities are required to report finance leases on the balance sheet as an obligation and related right of use asset. The subsequent impact on the P&L will result in a front loading of expenses. Some experts believe this could make financial statements much more volatile in the future — and possibly have a substantial impact on the lessee’s debt/equity ratio. It could also affect an entity’s overall credit worthiness from a bond issuance perspective.

Adopting and complying with Statement 87 guidelines has presented unexpected challenges. For those still working to meet the deadline, there are lessons to be learned from entities further down the path to compliance. The following are 10 of the most common mistakes encountered on the road to Statement 87 compliance:

Underestimating the impact on accounting systems

The new regulations place greater demands on the capabilities of application technology, requiring existing lease accounting systems to be updated or replaced altogether.

Extra time is required to procure and implement a system capable of compiling, processing and reporting on the important lease data needed by accounting and financial reporting departments. Often the amount of time required, from both a systems as well as an operational and internal controls perspective, is underestimated. In most cases, timelines have been severely affected by limited resources and ongoing demand from the business.

Limiting compliance impact to lease accounting and real estate teams

Identifying and thoroughly evaluating the impact to all functional departments has proven to be one of the biggest challenges so far. Representatives from multiple business functions need to consider the possible impacts of Statement 87. The team designated to oversee this leasing transformation should include specialists from real estate, budgeting, accounting, financial reporting, internal audit, IT, legal, procurement and human resources. The Treasury should also be involved due to the potential impact on debt covenant compliance and debt issuance impacts.

It’s vital to ensure the project is prioritized appropriately and people are assigned to make it a success. This can be addressed by appointing a senior-level “champion,” who has enough clout within the organization to drive the effort forward. This person must ensure sufficient resources are made available, host regular meetings to plan and review progress, and maintain a communication channel with the next level of management.

Failing to appreciate the change in approach and impact on financial statements

In Statement 87, GASB decided to follow the IASB model of solely recognizing finance leases rather than the dual model adopted by FASB. GASB had previously deferred to guidance issued by FASB in ASC 840. The major advantage to the single model is the lessened burden of managing two classifications. The major disadvantage relates to the front-loaded expense impact. The front-loaded recognition of expenditures will certainly impact the budgeting and debt issuance strategy for future fiscal years.

Assuming all lease data is readily available and accurate

It is essential to ensure all leases are properly identified and reviewed at the earliest possible stage. Many start out believing they have comprehensive lease data on hand, only to find that a number of leases were not fully abstracted or readily available. According to a survey by Big Four firm PwC, 60 percent reported difficulties in identifying their complete lease population.

In some cases, the information required to calculate the net present value and right of use for a lease, such as fair market value of the asset and discount rate, was never documented. In other situations, leases that are exempt from the new standard, such as short-term leases, had not been identified.

Failing to identify all leases

To properly manage compliance, all leases need to be captured in a lease accounting system. Carefully analyze arrangements that are not typically thought of as leases, such as outsourced warehousing, data management, data centers, supply agreements or service contracts. To help find unidentified service contracts, look for recurring payments for the same amount every month. Analyzing the arrangement may reveal a lease embedded within a service contract.

Relying on old policies and procedures

While implementing new technology to help ensure full compliance with Statement 87, review internal policies, procedures and control processes relative to the Sarbanes-Oxley Act and consider re-engineering them. Challenging old controls and procedures could yield real benefits by modifying controls to be more efficient, as well as effective. Determine which changes need to be made and, more importantly, who will maintain them post-implementation.

Resisting change

The way entities approach lease accounting and financial reporting will never be the same again. Old methods won’t be capable of compiling, processing and analyzing all of the important lease data needed by accounting and finance departments, so things may have to change. Because people are often apprehensive of change, a shift to new processes may require some form of change management. Assign someone to lead the charge, inspire others to join in and illustrate how this new approach will make their jobs easier and better.

Not asking for help

The GASB transition and adoption periods present complex challenges. The board is good at telling companies what to do, but not so good at explaining how to do it. Thus, it’s important to know where limitations exist. Accept that outside support might be necessary and get it. When unsure how to interpret a part of the standard, speak with your independent auditor before making a move.

Misunderstanding cost

Many set out on the road to compliance without a clear idea of what it will cost to adopt and transition to the new standard. Without thinking broadly enough about the range of stakeholders from the beginning, it’s tough to budget realistically for overall internal and external system implementation costs. New software, the need for additional resources and training, and the amount of extra management time spent collecting lease data can all contribute to higher than expected costs. It’s also easy to underestimate the external costs involved — such as needing auditors for advice and the services of other outside contractors.

Not enough time for robust testing

At least three months should be allotted for proper testing. Start by thinking through what needs to be tested from an entity reporting and compliance standpoint. Create documented test scripts for each unique scenario, such as non-standard period leases, rent holidays, right of use adjustments and renewal options, and lease obligations. Re-calculations must be performed outside of the lease accounting system in order to validate the process. The new lease accounting standards impose a much heavier accounting and reporting burden; therefore testing is vital to ensure accurate and audit friendly reports can be provided.

With the GASB Statement 87 deadlines looming, many finance and real estate leaders are scrambling to prepare. Experts have repeatedly warned of severe consequences for those not ready to comply with the new standards. However, compliance doesn’t have to be a doomsday scenario. Put the right technology and processes in place and learn from the challenges others have already overcome.