How to Abstract, Manage and Report on Lease Data
When FASB issued its update to the lease accounting standard, the main goal was to increase the transparency and comparability of financial reporting.
Unfortunately, there are many complex decisions and actions required to successfully achieve compliance. You’ll want to make sure to provide yourself with enough time and resources to get it done right.
Fortunately, you’re not alone – and hundreds of public and private companies have already gone through this process. With proper insight into common potential obstacles, you can more clearly navigate through the process and achieve success.
While there is certainly no shortage of difficult tasks to achieve compliance, we’ve narrowed down the top 4 common lease accounting challenges experienced by public companies – and how to solve them.
Challenge 1: Centralizing all leases in one place
A crucial first step in the transition to ASC 842 is to identify all leases held by an organization and enter the pertinent information in one location.
To do so, you will need to start by gathering each lease within your organization, including any leases that may be part of a contract, such as an embedded lease. This effort requires careful analysis and judgment – and typically involves extensive coordination across departments and business units to ensure all leases are included.
Often a time-consuming and cumbersome exercise, it is crucial to provide your organization with ample time to complete this step. (For help with your project timeline, request a customized milestone planner to outline when to begin).
Once all the leases within your company have been identified, you’ll need to import important lease information into a centralized location to help you view all your leases in one place and access lease information at any time.
This step often contains a high volume of labor-intensive work. Extracting lease data (also known as abstracting) from complicated contracts is a complex task that will need to be done for every lease – and any time your company signs new leases and modifies existing lease contracts.
Depending on the size of your company and resources available, you may need to assess whether it is better to perform this this task in-house or with external professional abstracting resources.
Challenge 2: Identifying technology that does more than calculate
Your chosen lease accounting technology is just as critical to the lease accounting standard transition and will greatly impact your ongoing ASC 842 compliance.
While some solutions may sound similar on paper, only a select few are able to provide you with the proper tools to ensure your company’s lease information is accurate at the get-go, and remains up-to-date over time with minimal effort.
If you are in the market for a system, don’t settle for any solution that promises to produce accounting calculations. You’ll need to make sure it also makes it easy to facilitate ongoing, long-term compliance by properly tracking lease updates.
From the start, look for a tool that can deliver the following:
- System Integration Capabilities: Lease accounting data should be able to easily integrate into necessary third-party applications to further automate of journal entries, financial disclosures and accounts payable information. Previously, many companies did not pay attention to integrating their leases within their accounts payable system, but with the advent of the new standard, your business may benefit from re-examining its payment processes through a solution that facilitates integration between accounts payable and the lease information.
- Lease Management Features: Ensure up-to-date lease information with a tool that makes it easy to track and manage leases on an ongoing basis. With lease information that is searchable and available at a glance, your business can stay on top of payments, renewals and options, as well as compliance requirements.
- Modern Software Updates: Don’t get stuck using a system that doesn’t prioritize developing new features and capabilities. To keep up with the most current trends in lease accounting, you’ll want to make sure your chosen system is dedicated to helping you achieve your goals and saving you time by releasing new innovative features and functionality.
Save yourself the trouble and inefficiencies of a tool that under–promises its ability to deliver what you need – and more importantly, consider the long-term impact of lease accounting software to avoid having to start all over again after you’ve already done the hard work of preparing for the lease accounting deadline.
Challenge 3: Making critical decisions that impact business financials
In the early stages of transitioning to ASC 842, there are a number of essential, albeit challenging decisions that companies are responsible for, which impact overall lease accounting and reports.
- Applying the ASC 842 Guidance: When transitioning to the new standard, companies can elect one of two approaches to apply the guidance:
- Most commonly, you can retrospectively apply the guidance at the beginning of the period of adoption through a cumulative-effect adjustment, known as the modified retrospective approach. In this approach, you no longer are responsible for capturing leases you no longer hold. However, this option presents its own challenges, requiring all lease data to be current and up to date.
- Uncommonly, you can retrospectively apply the guidance to each prior reporting period presented in your financial statements along with the cumulative effect of the initial application, to the earliest period presented. In this approach, you are restating prior periods as the standard had applied to them, which presents an enormous challenge to recalculate and apply the current standard to leases you no longer hold.
- Determining Discount Rates: Companies need to exercise judgment when determining their discount rates. The elected discount rate can have a substantial impact on your balance sheet.
- For lessees, if the discount rate is clearly stated within a lease – called an explicit rate – the lessee is required to use that. However, it is rare for a lease to include this – and nearly impossible to calculate without it. To do so, the lessor would need the lessor’s financial information to determine this discount rate.
- If that rate cannot be easily determined, companies can use the incremental borrowing rate (IBR). The IBR is the rate you would have to pay or borrow on a collateralized basis over a similar term. While this is a more common option to select, it also presents its own challenges. IBRs are often easier for big companies, but more difficult for private companies. However, it’s common for private companies to pick a risk–free rate.
- Payments and Allocations: When calculating lease liability, companies must decide whether to consider renewal periods and termination periods, which ultimately impact the length of liability (and financial obligation) in financial reports.
- You may also choose to allocate lease payments between lease components and non-lease components, depending on what practical expedients (see below) your company has elected.
- Policy Elections: When choosing policy elections, it’s important to consider the current policies and types of lease contracts.
- Selecting policy elections help to determine the broader impact, rather than just the immediate impact on your financials.
- Disclosure Requirements: While the new standard includes quantitative and qualitative disclosure requirements, companies are responsible for more than the minimum reports documented in the guidelines.
- Company management needs to consider the disclosure requirements within existing lease contracts and plan how to gather the relevant disclosure information. Organizations must be able to explain the changes made within their balance sheet period–over–period – and may do so through a roll-forward report.
- Practical Expedients: FASB allows certain practical expedients to facilitate transition accounting and general lease accounting.
- You should select the practical expedients carefully after considering your current accounting policies and the broader impact of these practical expedients.
- You may need to choose some of these elections as a package, as described in ASC 842 Practical Expedients and Transition Requirements.
Challenge 4: Meeting ongoing auditing, risk management and tax accounting needs
Early coordination with auditing, risk management and tax functions of your company is another important element of planning that commonly presents challenges for companies while adopting ASC 842.
- Auditing – This standard is brand new – and there’s flexibility in the guidelines, which leaves some areas open to interpretation. Meet with your auditors early in the adoption process to help substantiate your decisions – which will only save you time when it comes for the time of the audit. This helps ensure that any questions about system controls are addressed prior to transition to ASC 842, including:
- The overall control environment surrounding leases
- Automated versus manual controls
- System implementation requirements
- Risk Management – There are now higher stakes to having an accurate balance sheet with up-to-date lease information. Therefore, effective risk management includes a high level of interaction between lease accounting and administration to keep accurate lease financials and ensure payments are made on time. To do this properly, a selected lease accounting system should include the ability to identify and maintain leases.
- Tax Accounting – While tax accounting is often separate and distinct from financial accounting, recognition of deferred taxes may be a component of lease accounting. So, confer with your tax expert to make sure the general ledger and the lease accounting system properly consider deferred taxes.
Although there are various decisions ahead that require careful consideration for the lease accounting deadline, there are many resources available to help. Hundreds of public and private companies have already navigated the various requirements – and achieved success, which you can learn from.
By arming yourself with as much information as you can ahead of time, you too can be prepared to reach lease accounting compliance. Furthermore, a lease accounting system can provide you with an automated, easy transition to the new guidance – and result in significant savings for your business that you may have previously overlooked to help control, reduce or negotiate lease costs.