Lease accounting standard leaves companies with questions
As companies get ready for the new lease accounting standard, they’re coming across a variety of complications and questions before the standard takes effect in the next few years.
Deloitte recently issued a publication with answers to some of the frequently asked questions its clients have encountered. “From an implementation perspective, companies are now digging into the meat of the preparation activities,” said Deloitte Risk and Financial Advisory managing director Sean Torr. “There’s a sense over the next 12 months there’s going to be a time period of heavy lifting around the standard.”
He noted that companies are exploring system solutions to help with the standard, including upgrades and entirely new systems. “Companies are grappling now with the data effort, which is the extraction of this information that’s required for the new standards,” said Torr. “They’re also thinking through the process and controls. Clearly the standard involves a lot of interpretation and technical nuances, and questions are coming up.”
The new standard will take effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2018. For private companies, it will take effect for fiscal years beginning after Dec. 15, 2019, and for interim periods within fiscal years beginning after Dec. 15, 2020.
Under the new leases standard, companies will have to consider a number of transition challenges, including judgments as to what qualifies as a lease under the new standard, managing complex data collection and storage, improving information technology infrastructure necessary for compliance, sharpening internal controls and addressing the potential tax implications.
“From an accounting perspective, one of the big issues that folks are focused on now is the rules around the transition,” said James Barker, senior consultation partner at Deloitte & Touche’s national office accounting services. “When you transition from the old lease rules to the new lease rules, there are some complexities and nuances that weren’t addressed directly by the standard. We have regular dialogue with FASB and the SEC on the new lease standard, and at least half of the dialogue lately seems to be around transition.”
The versions of the leasing standard from the Financial Accounting Standards Board and the International Accounting Standards Board differ somewhat despite the boards’ years-long convergence efforts, but they both make the major change of putting operating leases on the balance sheet. One of the sample questions in Deloitte’s new “Heads Up” FAQ document involves whether an entity needs to evaluate a service arrangement that involves the use of property, plant and equipment to determine whether the arrangement contains a lease.
“The on balance sheet treatment was really the emphasis of the standard,” said Barker. “The reason we have the new standard is to bring about that result. Where a lot of companies are getting caught is this notion that leases aren’t just of real estate or equipment. Leases can also be things that are embedded in service arrangements. You are acknowledging the whole notion that if I have a service arrangement, and it involves the use of specified equipment, even though the agreement doesn’t say lease on the front or isn’t legally considered a lease, it can be a lease from an accounting perspective. Those are the ones that are quite tricky. People historically haven’t thought of those arrangements as being leases and they haven’t necessarily included them in their lease accounting or their disclosures, but now that’s going to change.”
The process can involve some complex analysis and may be difficult for many companies to keep doing that analysis in the future. “You’re thinking about not just the initial adoption, but also what is the most efficient process for the organization to be able to maintain that analysis going forward,” said Torr. “This becomes more problematic for companies that are decentralized, maybe covering multiple countries, putting in a consistent approach. Once you’ve gotten through the initial implementation hurdle, how can you maintain this efficiently moving forward?”
Conversely some leases may not need to go on the balance sheet if they don’t reach a certain threshold, and that could simplify the transition for some companies. The FAQ document also addresses whether or not a lessee can use an appropriate capitalization threshold when evaluating the requirement to recognize, on the balance sheet, leases that otherwise require recognition under the FASB accounting standards update.
“Most of the companies that we work with are still figuring out how they’re going to approach those issues, particularly the one about the capitalization threshold because that’s important,” said Barker. “That’s going to mean a certain population of your leases, even though they’re technically leases, are immaterial enough to not require the application of the model, and that includes balance sheet treatment as well as some of the new disclosure requirements. Companies should be actively working with their auditors on that, because you want to make sure the auditor agrees with whatever capitalization threshold you intend to apply. It would be a shame to go through a lot of work and then have your auditor tell you a year later that you’ve set that threshold too low. It’s important for companies to work with their auditors now and get agreement on that. For the average company, that could take a good number of your leases out of the new standard and it would make it quite a bit easier.”
The decision can have technology implications as well. “If a company does elect that approach, then the question is from a systematic perspective and a process perspective how to maintain the differentiation between the assets that are in scope and those that are out of scope, so you don’t have a commingling and a tracking issue,” said Torr. “The tracking of this is an important aspect. So it’s the judgment upfront, it’s the vetting with the auditors, and making sure on the back end you have that tracking mechanism in place.”
Other questions that may come up include whether an entity (lessee or lessor) should include noncash consideration in its determination of lease payments, and do index- or rate-based payment adjustments in a lease require the lessee to re-measure the lease? Another hurdle is the fact that companies are also getting ready for FASB and the IASB’s new revenue recognition standard, which goes into effect about a year earlier than the leasing standard.
“One of the things we’re finding is that a lot of companies we talk to are still primarily focused on getting revenue implemented, and leasing is still somewhat secondary to revenue,” said Barker. “From my perspective, we’re still not getting the attention that we would expect a new big standard like this to get from companies. I think it’s going to come, but I’m just not sure it’s here yet. It could be a whole another wave of questions and implementation issues that arise after companies really start focusing on it. Some of the bigger companies are pretty focused on it, but average companies probably are still making sure they’ve got the revenue standard figured out before they move on to some other large new standard.”
Businesses are unsure if their software is going to be ready to handle the new standard, along with the necessary technology experts. “I am hearing from more companies that they are concerned about the systems solutions to leasing being ready on time to implement by 2019,” said Barker. “It’s not necessarily just the applications, but the system vendors having the resources, the people to go out and implement these systems across enough companies. Over the last two or three months I’ve heard more of that talk. It’s important for companies to make sure that if they think they’re going to need a new system, they need to start talking to vendors now because we’re hearing that some companies are feeling quite a bit behind the eight ball on that.”
The systems will need to be sophisticated to handle the new standard. “The complexity of the business requirements that a system will need to comprehend are much more than initially meets the eye, and the devil is definitely in the details,” said Torr. “The nuances around modification accounting, the transition accounting, and some of the areas of judgment are difficult to program in the system. The issue for companies as they’re evaluating systems is to really go beyond just the initial appearance of what the screens look like. It’s really digging into the core accounting functionality and how it handles the complexities of some of these nuances. That clearly should be an area of focus for companies that are investing in these systems.”