If you’re a private firm just beginning to prepare for compliance with the new lease accounting standards (FASB ASC 842 and IFRS 16), consider yourself extremely fortunate. While you certainly face a big challenge ahead in 2019, you have the advantage of learning from the pitfalls that many public companies made with lease accounting implementation in 2018.
Last year, Visual Lease worked with hundreds of global public companies going through lease accounting implementation. In this article, we’ll explain the missteps and oversights we saw that resulted in wasted time and effort, caused project delays, and opened up these firms to significant risk of inaccurate financial reporting. We’ll also share advice to help private firms avoid these pitfalls and experience a smoother (and less stressful) transition.
Costly lease accounting implementation pitfalls by public firms (and how private firms can avoid them)
1. Underestimating the time and resources required
Ask anyone who spent 2018 helping public companies through lease accounting implementation projects, and they will all tell you the same thing: many firms underestimated the time and the resources needed to get it done. So they waited too long to get started. And they failed to engage the help they needed early enough. We actually had a company come to us only 4 weeks prior to their January 1, 2019 implementation deadline! We were able to help, but needless to say it was a difficult period for them that stretched right up until their first quarterly reporting date in March.
Before accounting teams fully understand the scale and the scope of transitioning to FASB ASC 842 and/or IFRS 16, they often assume it will be a simple matter to gather data, do a few calculations, and produce journal entries. In reality, there are many more accounting complexities, logistical issues, and technical details than you may expect. If you wait too long to start or fail to plan for adequate resources, you can easily be blindsided by unexpected issues and wind up not being ready in time to meet the compliance deadline.
Read this for details you might not know about lease accounting implementation: Lease Accounting Compliance Deadline: Will You Be Ready?
2. Choosing the wrong implementation team
Because lease accounting implementation is a complex project with high stakes and many stakeholders, we highly recommend having an experienced project manager spearhead your effort. That person could be someone from your own internal project management team, an outside consultant, or even a representative from your accounting advisory firm.
When it comes to putting together the rest of the team, don’t go too big or too small. With a team of 15 people, you’ll face analysis paralysis and take too long to make decisions. However, if you leave out key stakeholders, you run the risk of making mistakes that are costly and time consuming to fix later.
For example, it’s essential to include representatives from Real Estate and others who manage your leases. These lease experts can make sure you are collecting important data that you’ll need for performing calculations and journal entries. For example, we worked with one company that came to us thinking they had all their data ready for importing. However, they missed an important component: they had no commencement dates for their property leases. That happened because they collected payment information with no input from the Real Estate team.
Read this to learn more about putting together your team: FASB Lease Accounting Changes: How to Assemble Your Readiness Team
3. Configuring your lease database too soon
It’s certainly smart to engage your lease accounting technology vendor early in the process. However, software implementation starts with gathering your requirements and building a database. If you have not yet made accounting decisions and begun to gather your lease data, you might not be ready to configure your database just yet.
Your vendor will ask questions during this process that you might not be ready to answer. If you guess wrong, you could make errors that mean re-work later.
The most efficient strategy (both for optimizing time and choosing the right software) is to make accounting decisions and gather data while you’re shopping for technology.
4. Making accounting decisions too late
We have seen too many companies jump into data collection before making the important accounting decisions that affect exactly which data points are needed for lease accounting calculations.
Practical expedients are a good example. The practical expedients you elect to take have an impact on how your data needs to be structured and broken down. We saw a company that had centralized all their lease payment data only to realize that due to a practical expedient they needed to break lump sum rents down into lease and non-lease components. That caused considerable re-work very late in the process, eating up the time they had planned for testing (more on testing to come).
Discount rates are also frequently overlooked. Some firms decide to use the same rate across the board for all leases, while others use a complex table of rates for different types of calculations. To avoid time consuming re-work and costly delays, It’s important to make those decisions BEFORE running your lease accounting calculations and producing journal entries.
5. Failing to validate your data
When it comes to testing, many firms focus on validating the mathematical calculations produced by their lease accounting software. Of course we don’t recommend skipping this due diligence, but remember that software vendors, global public companies, and major accounting firms have already completed this process thousands of times over in 2018, and the platforms do work. Here’s the part you must focus on: making sure your lease data is complete and accurate.
Under the previous standards, more than 80% of leases were operating leases with little impact on the books. Under ASC 842 and IFRS 16, the impact is much greater. Now you will have both an asset and a liability on your balance sheet for nearly all leases. If your data is wrong, the accuracy of your financial reports is compromised. We don’t need to tell you how serious the consequences can be when that happens. You could end up violating a debt governance. Reporting errors often require time-consuming investigation and adjustments to fix. That’s why transitioning to the new standards requires a higher level of lease data accuracy than ever before.
Are you sure you have a complete set of payment data from all leases? Are start and end dates valid? Have you included lease amendments?
Here’s what we’ve seen: companies are assuming all their calculations are correct until they run their first set of live reports shortly before the end of the first quarter. Then they realize the numbers are way off as compared to the actual expenses for that time period.
We recommend developing models and testing with your actual lease data to uncover anything that you might have missed. If you find inconsistencies, you need to dig into what’s missing or incorrect in your data.
How can you avoid this last-minute panic?
- Include all lease stakeholders in the process so you capture accurate and complete data from the outset.
- Start collecting data now and get it your lease accounting database as early as possible.
- Plan for plenty of time for data validation.