Tips for lease accounting implementation

By Liz Farr, CPA

When General Dynamics Mission Systems started implementing FASB’s new leases standard, Adena Lerner was told it would take hours to extract the information from each lease that is needed to comply with the standard and add it to the accounting system.

“That held true,” said Lerner, the controller for the technology company and defense contractor in Fairfax, Va.

Other finance executives who have started implementing the new standard provide a similar refrain. The time and resources required to implement FASB’s new lease accounting standard should not be underestimated.

“It requires a significant amount of time and resources to read through every single lease and pull all of the various terms out,” Lerner said during a panel discussion at the AICPA Conference on Current SEC and PCAOB Developments in December in Washington.

The leases standard takes effect in 2019 for public companies and in 2020 for nonpublic companies. Issued in February 2016, FASB Accounting Standards Codification (ASC) Topic 842, Leases, requires lessees to report on the balance sheet assets and liabilities related to leases of one year or more.

In some cases, locating all of a company’s leases and extracting the data required to comply with the standard has been a serious challenge for financial statement preparers. Lerner’s group began planning the work in the summer of 2016 and is still working on it. With an estimated 26,000 leases to account for around the world, the team faced a daunting task.

Cathy DeGenova, CPA, director of SEC reporting and technical accounting at Avis Budget Group in Parsippany, N.J., said her organization initially underestimated the time the project would require for an estimated 4,000 leases. “We didn’t understand in the beginning of the project how much time the data collection and data entry would take,” she said at the SEC/PCAOB conference.

Both expressed relief at FASB’s recent decision to simplify the implementation process. The board decided to provide an optional practical expedient for transition, to clarify land easements guidance, and to propose other measures designed to decrease the burden on preparers.

While those actions may make implementation less difficult, the standard still presents a formidable challenge to preparers. The following tips can help make the process smoother.

Get your arms around your lease portfolio

The first step in implementation is to gather all the leases, which may not be as simple as it sounds. For large, decentralized organizations such as Lerner’s and DeGenova’s, this required thorough study of accounts payable ledgers, asset registers, vendors, P-card purchases, detailed financials by country, and information from subsidiaries.

“The data collection was the biggest hurdle to cross for this particular standard implementation,” Lerner said.

Both reported pushback from their organizations, especially for the leases of small items, which might be immaterial. However, Lerner wanted to ensure that she was gathering enough data to prove to the auditors that their controls were working. She also feared setting a threshold for materiality within the organization that wouldn’t capture future leases.

“If we say there’s a threshold, people will go back to their old ways, and leases may not be maintained under that particular threshold,” she said.

Cross-functional engagement is required

Implementing this standard requires cross-functional cooperation and collaboration across an entire organization.

“The number one issue was resources and getting pushback, that the teams didn’t have the time or effort to put in to help us with the project,” said DeGenova. Both Lerner and DeGenova enlisted outside assistance to get their existing leases into their new systems.

When implementation at General Dynamics Mission Systems began, Lerner encountered confusion from other departments that had rarely worked with accounting before, and had never worked on implementing accounting standards. “But now, a year later, we work hand-in-hand with procurement and real estate. Legal, too,” she said.

Under the new standard, lease terms can have significant repercussions for an organization’s financials, so both Lerner and DeGenova described the need to educate all the players — including procurement, real estate, IT, and legal — about the potential for negative impacts of particular lease terms. DeGenova’s organization held workshops to educate everyone in accounting and real estate on the new standard.

Ongoing education across the organization and deepening relationships with other areas of the organization will also be key.

Implement a lease management system

Many organizations have previously relied on Excel to manage their leases, but the complexity of balance sheet entries, disclosures, and calculations required for compliance with the lease accounting standard may exceed Excel’s capabilities, unless an organization only has a few leases. Lerner and DeGenova both recommended using a dedicated lease management system.

When choosing a lease management system, DeGenova recommended using a scorecard to evaluate the options that are most important for an organization.

“Can it handle equipment and real estate?” she asked. “Does it produce the accounting reports you need? And does the system integrate with your ERP system? And does the software scale to meet your needs?”

Lerner suggested looking at the capabilities of an organization’s existing real estate system, as these systems are expanding their capabilities for dealing with the nuances of Topic 842. The real estate system at Mission Systems was sophisticated enough that they didn’t have to read every real estate lease. Instead, their real estate system produced data that could be easily imported into their lease subledger.

Manage international challenges

Organizations with international operations face additional challenges. Leases may be in different languages or use a different format. The original documents may have deteriorated and may be illegible. Foreign exchange adds another layer of complexity. DeGenova was surprised at how decentralized the international leases were. Her organization identified and educated a lead for the international team and set up a separate timeline.

Lerner noted that EU privacy laws added further complexity by restricting the type of information an organization could upload to its cloud-based system.

Make a plan for the long haul

While the effort to implement this standard is herculean, Lerner said that “this is not a one-time call for data. It’s going to be lifelong.” When selecting a lease management system, she also recommended evaluating the process for adding new leases to make sure the chosen system was not cumbersome.

Both organizations digitized all leases and added them to an online database. DeGenova noted the “operational benefits to having all your leases in a central repository.” Now with all the data in a lease management system, the real estate team and the procurement team can perform detailed analysis on the lease portfolio. These operational benefits helped to get buy-in from others in her organization.

DeGenova’s group developed a process that brought new contracts through her team to identify embedded leases. And people across the organization are now educated enough to bring her other contracts that may contain leases. Developing policies for leases will ensure that controls are in place over the process.

Lerner’s group at Mission Systems is centralizing the process for managing leases and is developing a checklist of items in new leases that will require review. On an ongoing basis, there will be points where finance will be alerted when lease terms change.

For companies that haven’t yet begun the process, Lerner advised thinking about the ongoing process for compliance.

“I wish we had taken a step back and addressed the future state at the onset,” she said. “Because that’s what we’re doing right now, and ensuring that going forward that all of our leases continue to get put into the system. We do not want to backslide into a situation where it’s a fire drill to get all of these leases into the system.”

Liz Farr is a freelance writer based in Los Lunas, N.M. To comment on this article or to suggest an idea for another article, contact Ken Tysiac, editorial director, at Kenneth.Tysiac@aicpa-cima.com.

SPONSORED REPORT

Tax reform changes are now in effect

With all the recent tax law changes, this year it’s more important than ever to make sure your clients’ tax situations are squared away before year end. This report provides necessary guidance to ensure 2019 starts without a hitch.

PODCAST

Using drones to enhance audits

Hermann Sidhu, CPA, global assurance digital leader at EY, walks us through EY’s exciting new project to use drones to help audit large warehouses and outdoor inventories.