SEC Disclosures Show Major Impact to Balance Sheets From New Lease Accounting
Standards, What Companies are Doing About It
What are the new lease accounting standards?
The new lease accounting standards are a result of the efforts of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) to close a major accounting loophole. Under the previous lease accounting standard, companies were able to report a certain type of lease, called operating, off-balance sheet. The new standard will close that loophole by requiring companies to report their operating leases on-balance sheet as right-of-use assets and lease liabilities. The hope is that this change will increase transparency into the true financial position of corporations.
As a result of the updates, the IASB estimates that over $2 trillion of lease assets and liabilities will transfer onto company balance sheets as a whole. But now that the deadlines for the new standards are moving closer, many are wondering how individual companies will be affected.
What are the new SEC disclosure requirements?
LeaseAccelerator analyzed the SEC mandated SAB 74 (Staff Accounting Bulletin, No. 74) disclosures of the 100 companies with the highest leasing obligations out of the Fortune 1000 to determine individual company impact. SAB 74 disclosures are a recent requirement for companies to report on the impacts of the new accounting standards, including the new lease accounting standard.
What have companies disclosed about the impact to financial statements?
The first deadlines for implementing the new standards are not until January 1, 2019, so unsurprisingly many companies are still in the evaluation phase of their projects. These companies have hundreds to thousands of leases to analyze, a time-consuming process. Despite the scale of the project, of the 100 companies analyzed, 82% of companies were able to conclude that there would be material impacts to the company balance sheet. Only 2 of the companies, Bank of America and UnitedHealth Group, did not anticipate a material impact. The remaining 17 companies were still in the evaluation process or did not state whether a material impact was expected. Only a few of the companies provided a quantitative estimate of the impact to the balance sheet, and those estimates ranged from $1.3 to $13 billion. Almost no companies predicted a material impact to the income or cash flow statements.
What are companies doing to implement the new standards?
While many companies are still in the beginnings of their implementation projects for the new lease accounting standards, some companies reported that they have begun making decisions about practical expedient selection, lease accounting software, and design of future processes.
Practical Expedient Selection: The new lease accounting standard offers various practical expedients to help companies transition to the new standard. 19% of companies stated that they are either evaluating or have selected practical expedients. While all of the expedients are designed to help companies transition to the new standards, it’s still crucial for companies to analyze the impact of each expedient on their financial statements and company metrics. As evidenced by the disclosures, not all companies will want to select every practical expedient.
Lease Accounting Software: Due to the size of the lease portfolios at major companies, most, if not all, will find it necessary to implement a lease accounting software capable of handling all of their operating leases under the more complex standard.
While many companies have managed their lease portfolios on spreadsheets in the past, the new standard requires significantly more detail on leased assets. In some cases, over 100 data fields per lease will need to be collected, including information on payments, expenses, and lease options to accurately perform the accounting for each lease. That level of detail will be difficult to maintain on spreadsheets alone, and attempting to complete the accounting manually will increase risk of error. As a result, many companies – at least 25% of those analyzed in the study – are already in the process of evaluating, developing, or implementing a software solution for the lease accounting project.
Processes and controls: To implement the new standards by the deadline and to maintain compliance beyond the deadline, many companies are realizing that they need to update the processes and controls for their leasing program. 27% of companies reported that they are evaluating or implementing updated processes and controls, though few elaborated on what those looked like at their company. Based on LeaseAccelerator’s work with Fortune 1000 companies as well as the requirements of the new standard, we have found that there are some best practices for designing processes and controls that companies should consider.
For example, companies need to have a control in place to ensure completeness of their data. Auditors are expected to focus on completeness as that is an expected area of weakness for many companies, so these businesses will need to prove that they have reported their complete population of leases. Many companies have instituted a lease versus buy policy to serve as the completeness control and make sure each new lease is documented.
Another area of focus is accuracy of lease data, or making sure that each of the data fields reported for each lease is correct and up-to-date. Since this information is best known by the employees actually using the assets, many companies have set up notifications to remind these asset users to check and update the data periodically, as well as a system of incentives and penalties to encourage these employees to follow through on updating the data.
As the SAB 74 disclosures demonstrate, there is no one right answer when it comes to adopting the new standards. The degree to which companies will be impacted, as well as the methods they use to implement the standards will vary from industry to industry and company to company. However, what is clear is that with the first implementation dates for the standards six months away, now is the time for companies to plan their implementation.
LeaseAccelerator offers the market-leading software-as-a-service (SaaS) solution for Enterprise Lease Accounting, enabling compliance with the current and new FASB and IFRS standards. Using LeaseAccelerator’s proprietary Global Lease Accounting Engine, customers can apply the new standards to all types of leases, including real estate, fleet, IT and other equipment at an asset level as specified by FASB and IASB. On average, LeaseAccelerator’s Sourcing and Management applications generate savings of 17 percent with smarter procurement and end-of-term management, delivering both compliance and ROI. Learn more at http://www.leaseaccelerator.com/.