Organizations are finally starting to prepare for the new lease accounting standard that will be taking effect in 2019, but as they do they’re running into some unexpected complexities.
Deloitte partners Jeanne McGovern and Derek Bradfield convened a panel last week at a Financial Executives International conference in Philadelphia to discuss the leasing standard.
“The FASB and IASB standards that came out in early 2016 fundamentally brought all leases on the balance sheet,” McGovern told Accounting Today. “While those standards are similar in that regard and were originally a convergence project for the IASB and FASB, they definitely diverged quite a bit and created a number of differences which create complications for global companies that report in both U.S. GAAP and IFRS. That was really the focus of the panel that we did at FEI.”
They heard from a number of companies that they are behind schedule in getting ready for the new leasing and revenue recognition standards. “I think there are probably a couple of reasons for that, one being that the revenue recognition standard comes first, and therefore companies are focusing on that,” said McGovern. “Secondly I think the issue is that revenue recognition is technically a much more complicated standard. The leases standard is less complicated than revenue, but certainly has other challenges in terms of the amount of data required to implement that standard.”
Bradfield too sees many companies focusing first on the revenue recognition standard, which takes effect next year, but he believes they may be underestimating the amount of work involved. “The accounting itself isn’t that complicated, but they underestimate how difficult it will be to implement the new lease standard just because of the sheer amount of data that they’re going to have to gather in order to comply,” he said. “As we’ve done these projects, we’ve learned that for the more complicated lease contracts that you have, you can need up to 75 different data points just to determine how to account for your lease. Multiply that by 1,000 or 2,000 leases, and the amount of data that you have to gather is probably not going to work on spreadsheets anymore, like what most companies have been doing for lease accounting. They’re going to need a system. I think people are starting to appreciate that more.”
Retailers are likely to see major headaches. “Retail companies generally rent all the different spaces that they’re in,” said Bradfield. “There tends to be thousands and thousands of real estate leases that they need to have, so there’s a big impact there just from the volume of leases. For anybody who has a storefront in multiple geographies, that will be the case. If you’re a multinational company, that adds to the problem.”
Another industry that will see a big impact is the energy sector, where many companies will be dealing with embedded leases, contracts allowing another party to control the use of an asset. “Whether that control is conveyed through a contract that has the word ‘lease’ in it or a contract that maybe is viewed as a service contract, it doesn’t really matter,” said Bradfield. “The energy industry has a lot of these types of embedded leases in their purchase agreements that are viewed as embedded leases. That’s a whole different exercise in itself just going in and identifying all of those embedded leases.”
Companies such as WeWork that sublet space to multiple companies will also need to grapple with the standard. “They’ve got it on both ends,” said Bradfield. “They have to deal with the fact that they’re leasing a space themselves and subleasing components of that space to their customers. When you have a shared asset, is that really a lease or not? There’s some complicated accounting around that. The companies that are in that position have to deal with both the lessee and the lessor accounting, which are both a little bit different. I think lessor accounting is more complicated than people were expecting as well.”
While the new standard mainly makes changes in the accounting for lessees, lessors will need to understand the various changes as well. “We all thought initially that there were very few differences in the lessor accounting, but as we’ve gotten into the details of it, it’s become more complicated than expected,” said McGovern. “By the volumes it certainly looked like lessee accounting changed a lot more, but there’s more to the lessor than we originally thought.”
Multinational companies will also need to deal with the differences between the versions for U.S. GAAP and International Financial Reporting Standards after the Financial Accounting Standards Board and the International Accounting Standards Board were unable to fully converge their standards.
“They’re somewhat converged in terms of leases are on the books in both, but there are some important differences between the two,” said McGovern. “It is requiring multinational companies with both of those reporting requirements to keep an IFRS set of books that’s different from their U.S. GAAP records. Given that the transition for the leasing standard is a modified retrospective, it means that you’re keeping old U.S. GAAP and new U.S. GAAP right now from ’17 through ’19, and then they’ll be keeping IFRS books under the old and new methods too because they have a slightly different transition approach. I wouldn’t want to have to do that.”
Companies may find it expensive to adjust their business processes and controls for the new leasing standard.
“The standard is making some significant changes to companies, and we do expect that they will be making a lot of changes to their business processes and controls,” said McGovern. “It’s one thing to have a footnote number on page 42 of your financial statements, and the controls necessary for that are very much more limited than those directly on your balance sheet, so there is a fair amount of change for people going through that process. It’s still fairly early in the implementation process. We’re seeing our clients that are still in the design phase, just kind of putting together how they will structure this and not necessarily quite into that implementation phase yet to be able to see the real results, but the change is important and it’s going to be substantial.”
Meanwhile companies are trying to automate the process as much as possible. “Most of the companies that I deal with expect to have to adopt some sort of automated system in order to help them comply,” said Bradfield. “Anytime you have a system that you need to implement, you have to get the controls that are around that right. The cost of buying a system and maintaining it is an additional cost. On top of that, do you have the resources to be able to deal with all of this, both in the initial adoption and ongoing, because you have thousands of leases you have to track the fair value of and make calculations for? How many people does it take to do that? So there’s an extra cost there that companies are anticipating too.”
Audit committees also have to be prepared for the new standard. “I think most companies are starting to do some education at the board level with their audit committee to make sure that they understand the implications of it,” said McGovern. “They are looking at companies’ implementation plans and just trying to understand how they’re assessing risks differently in this changed environment.”
“Audit committees are asking more and more questions,” said Bradfield. “I think they’ve learned their lesson from revenue: It’s better to start asking questions sooner rather than later. When people start panicking, which is what some are doing on the revenue side of things, we are starting to see them encourage management and the company to really focus on this while you still have time to get it right.”
Experts are warning companies not to procrastinate anymore. “Tell people the time is now to get started, because there’s a shortening runway,” said McGovern. “They need to be gathering a lot of information over the next 18 months to be ready for 2019.”