Last but not the lease-t: Preparing for the new leases accounting standards

Business World (11/07/2016; p. S1/4)

SUITS THE C-SUITE By Benjamin N. Villacorte

In the first quarter of 2016, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) released new accounting standards on Leases — IFRS 16 and ASC 844, respectively. While the standards differed on some key points, both boards noted that they fulfill the key objective of recognition of lease-related assets and liabilities by lessees on the balance sheet to enhance transparency. These new standards, which took almost a decade to finalize, could have a significant impact on all industries. Adoption could be challenging for many entities, especially for multinational companies that have decentralized operations and report both in US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). The differences between IFRS 16 and ASC 844 could also add complexity to the implementation.

To gain a better understanding of how and when companies plan to address the challenges of adopting the new Leases standards, Ernst & Young Global Ltd. (EY) and the Financial Executives Research Foundation, Inc. (FERF) conducted a survey of 125 companies last March and April. The respondents were from various industries, such as industrial products, chemicals and manufacturing, retail and consumer products, software technology, professional services and consulting, health care, entertainment and media, power and utilities, real estate, and retail and commercial banking. Titled “Paving a path to success: preparing for new lease accounting standards,” the survey highlighted the following:

· Nearly 90% of respondents said they are either somewhat or very familiar with the standards, with 33% saying that they are very familiar and have closely followed the FASB and IASB board activities.

· While 50% of all respondents have yet to take steps to prepare for the new standards, 11% have started to perform readiness assessments and another 7% said a designated project team has begun to create an inventory of lease data.

· A majority of respondents said they rely on spreadsheets to track and account for leases. More than 80% are still evaluating technology options, including 29% who have no current system for tracking leases.

· Nearly 60% of all respondents said they expect either a moderate or significant impact on their balance sheet and on their financial statement disclosures.

· Nearly 75% of all respondents expect to have significant or moderate difficulty developing policies, processes and internal controls, as well as getting through the first year audit.

· Among all respondents, 83% said they have not started to create a budget for meeting the new standards. Just 5% reported that they have designated more than $500,000 over the next three years to implement the new standard, and not earlier, with estimates of up to $5 million.

· More than half of the respondents (56%) were planning to adopt the standards as of the effective date.

The survey also showed that companies recognize the impact of the new accounting standards on their finance and other business functions. Preparing for the implementation could be an opportunity for companies to drive organizational improvements and savings in its leasing activities.

We recommend that companies consider the following in their plan for the adoption of the new Leases standards:

1. Understanding the current state of their leasing activities — It would be advisable for companies to assess existing lease arrangements and compare the lease procurement, lease administration and lease accounting functions that support these arrangements with the requirements of the new standards. This will allow companies to determine the extent of the required changes and appropriately design and plan the transition.

2. Identify the changes the new leases standard will bring — Companies should review the new standards and understand their financial and business implications, including the areas that would be impacted the most. This includes spotting the data gaps, processes, controls, systems, and tax areas which may be affected. It is also important to stay updated for potential changes that may emerge in the interpretation of the new standards.

3. Design appropriate solutions for the accounting change — They should start with identifying a cross-functional team and develop a project plan with effective project management to tackle the implementation. This is unlikely to be a ‘one-size-fits-all’ approach as the nature of leasing activities (i.e., the underlying assets, value and volume of leases), existing policies and processes, financial reporting requirements and strategic business decisions vary across companies. The solutions should also take into account the costs and time constraints to adopt existing policies, processes, controls and systems.

4. Implement the new accounting policies and systems with a view to capturing new lease data requirements and understanding the impact on financial statements — Users should anticipate and project the additional data requirements from the new standard and plan accordingly. They should also focus on how the new standard will be reflected in the financial statement disclosures and accounting treatment of existing and new leases. Part of this process necessitates ensuring appropriate governance, including seeking input from relevant stakeholders.

5. Begin transition — Companies should then determine the transition date and develop a transition plan that takes into consideration the resources available to the company, including people, budget and time.

The Leases standards may have been issued last among the significant new accounting standards, i.e. Revenue from Contracts with Customers (IFRS 15 and ASC 605) and Financial Instruments (IFRS 9) were both released in 2014, but it is definitely not the least important.

Preparing for an accounting change of this magnitude presents a considerable challenge. Understanding how the new Leases standards will affect the company is critical. All companies with significant leasing activities should begin thinking about its implications now to reduce the overall cost of implementation and avoid unwanted surprises and costly mistakes.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.

Benjamin N. Villacorte is a Partner of SGV & Co.