This article originally appeared on June 27th, 2017 and is authored by Michael Cohn of Accounting Today

Companies off to a slow start on lease accounting standard

Many companies are lagging behind on preparations for the new lease accounting standard as they are still working on the revenue recognition standard, according to a pair of new surveys.

The first survey, by PricewaterhouseCoopers and CBRE Group, found that 23 percent of companies have yet to begin the initial adoption process of the leasing standard, while 47 percent of organizations that started implementation of the leasing standard reported the effort is bigger than they had expected.

Many companies see the importance of the leasing standard, with 52 percent of the survey respondents indicating they are currently assessing the impact, and 25 percent have already started the implementation in process, according to PwC.

Lease accounting systems

The new leasing standards from the Financial Accounting Standards Board and the International Accounting Standards Board differ in some ways, but they both require all leases to be recorded on a public company’s balance sheet starting in 2019 (or 2020 for private companies). However, companies are still getting ready for FASB and the IASB’s revenue recognition standard, which takes effect about a year earlier than the leasing standard.

“I think companies are rightfully focused on revenue recognition, which is becoming effective at the beginning of next year,” said Sheri Wyatt, a partner in PwC’s Capital Markets & Accounting Advisory Services practice. “Many companies have limited resources they can dedicate to both of these efforts at the same time. While we’re seeing companies at least start the discussion about what the lease implementation process would look like, really getting deep into the implementation process is starting a little later, given the focus on revenue recognition, ensuring they’re prepared for that effective date.”

Many observers had anticipated that implementation of both standards might be a lot for companies to adjust to at once. “The results in terms of a company’s status in adopting the new lease accounting standard aren’t entirely surprising in the sense that 23 percent said they haven’t started, and 52 percent said they’re in the process of assessing the impact,” said Wyatt. “If you dig in deeper into assessing the impact numbers, about 48 percent are still in the early stages of assessing the impact. Companies are now starting to move forward from the revenue recognition implementation and starting to focus on leasing.”

In last year’s survey by PwC of readiness for the leasing standard, 84 percent of the poll respondents said they planned to begin implementation in 2017. However, in the newest survey, only 77 percent of organizations reported having started their efforts, with most of them still in the early stages.

Many companies will need to check their computer software to make sure it can adjust to the new standards. Seventy-four percent of companies are expecting systems changes, and more than half indicated they will implement or develop a new solution. However, only 23 percent said they have already selected a leasing solution. Currently, 70 percent of the poll respondents indicated they are manually collecting data from lease contracts in-house to comply with the new leasing standard.

“In most of the discussions that we have with companies, one of the first questions they want to understand better is what are the system options,” said Wyatt. “Most if not all of the companies that I’ve spoken to that have really large leasing portfolio systems believe that they’re going to need to have a system in order to be able to account for the leases, managing the leases appropriately as they’re recording and disclosing the leases correctly, and having the right controls and processes around them. I think companies are starting with that evaluation to see what the right solution would be for their particular organization.”

PwC has also been hearing feedback from the software companies about how they are handling the extra tasks. “The one thing that we hear from the systems vendors that we work with is that there’s an expectation on their side that companies are coming to them with the data elements that they’re going to need to be able to import into the system,” said Wyatt. “That really puts it onto the company to focus on identifying the full scope and population of the leases and be comfortable with the completeness, and then ensure they have all the data elements that they’ll need to go into the system.”

Different types of companies are coping with the leasing requirements by adapting their existing systems and checking to make sure they’re up to the task. “While we see some companies that have real estate management systems where they have a repository of terms, the question becomes on the real estate side ensuring that the terms that have been included in those repositories are complete,” said Wyatt. “If a company was just using it for real estate management purposes as opposed to accounting, there may be some elements in that repository that may not be complete. And also if they weren’t using it for financial reporting purposes, the question becomes how comfortable the company is with the quality of the information that may be in that repository. Gaining that level of comfort with the data can certainly save companies a good amount of time to gain that comfort.”

Companies with equipment leases have their own issues. “A lot of the questions and discussions we’ve had with clients have been on the equipment side,” said Wyatt. “Equipment is probably not the largest group of assets for many organizations. I think real estate clearly would have a big impact for many companies, but most of the time we find that equipment leases may not be managed in a centralized fashion, and some of the procurement decisions might be happening decentralized into various operating companies and subsidiaries. There may not be an equipment management system that has been tracking those key terms. That’s where we see many companies starting to sharpen their pencils around first completeness of the population, but then also developing an approach to get the data they need for the accounting.”

EY Leasing Survey

Ernst & Young also released a survey Tuesday of lease accounting readiness. EY’s survey found that only 27 percent of the respondents it polled are confident their companies are on track to meet critical milestones. However, 63 percent of the respondents acknowledge these changes are an opportunity to deliver business transformation, with process re-engineering, lease cost reduction and tax efficiency topping the list of benefits. The top risks they cited include systems challenges, the difficulty of collecting the required data, insufficient people resources and challenges interpreting the standard’s technical requirements.

Sixty-eight percent of the respondents plan to make systems changes. Forty percent of the respondents whose companies are moving to a new system believe it will take nine months or more, while 19 percent of the respondents think it will take less than six months. They believe that strong coordination among the finance, corporate real estate, procurement, IT, tax and treasury functions will probably be required.

“Companies want both compliance and transformation,” said EY Americas accounting change leader for leases Anastasia Economos said in a statement. “The survey results show that despite the challenges, lease accounting changes offer an opportunity to upgrade legacy IT systems and can help CIOs position their function at the forefront of business change. The majority of CFOs and CIOs see how these changes can align with broader goals and ambitions. What will likely bring success is strong alignment across the organization among finance, corporate real estate, procurement, IT, tax and treasury, as well as with internal and external audit teams.”

Double Adjustment

Tom Roland, a managing director at the business consulting firm MorganFranklin, sees companies adjusting to both the leasing and revenue recognition standards. “The revenue standard is consuming a lot of the capability and expertise of organizations,” he said. “It’s the headline for most companies. The impact on revenue is something that a lot of analysts and investors are acutely focused on. The importance of understanding and explaining the change and then the impact of additional disclosure and the transparency of the business is consuming a lot of the expertise of organizations. Contrast that with leases, which up until now have largely been an unreported item. Many organizations do a small disclosure as required for their future lease commitments that are not on their balance sheet, so it’s very much an afterthought.”

However, the upcoming leasing standard is becoming a worry for many investors. “There’s been some growing concern from the investor community that the distortion of future earnings is happening by the entering into of leases that don’t show up in your forecasts, but keep profitability to a level that’s inconsistent with the expectations that are being put out,” said Roland. “The standard is going to be fairly wide in impact, and it’s going to be focusing on a part of the business that simply doesn’t have the support or the expertise internal to the organization to help determine the impact. We’re recommending that organizations spend a little bit of time before the year is out to understand the state of their current lease arrangements and be mindful if they are making significant investments in systems or significant changes to their processes, they may want to evaluate the potential synergies of including some of the lease standard requirements.”

For more information about how MorganFranklin can assist with lease accounting, visit our Technical Accounting and Financial Reporting page.