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Much Work Remains for Lease Standard’s Implementation

Recent surveys from two of the Big Four accounting firms confirm what financial reporting professionals have been saying for months: the FASB’s new lease accounting standard requires the sorting through of large amounts of data, judgment calls on what constitutes a lease, and time and effort to put these transactions on company balance sheets for the first time. As the 2019 public company effective date looms, many companies are behind where they should be in the implementation process.

Companies that are behind schedule implementing the FASB’s lease accounting standard face a lot of work despite the accounting board’s efforts to make some aspects of it easier to apply.

With the 2019 public company effective date looming, many businesses may have to scramble to follow the new guidance, published in February 2016 as Accounting Standards Update (ASU) No. 2016-02, Leases ( Topic 842 ), which requires a sea change in how companies report their costs for renting everything from storefronts to jumbo jets.

“Folks have underestimated the effort around this,” said Dean Bell, partner in charge, U.S. head of accounting advisory services at KPMG LLP.

Recent surveys by KPMG and Deloitte & Touche LLP confirm what on-the-ground practitioners have been saying for months: the standard requires sorting through of mounds of data companies did not have to evaluate in the past, the use of judgment calls to determine what constitutes a lease, and time and effort to put the transactions on balance sheets.

KPMG on February 20, 2018, reported that just 15 percent of companies had completed the process to implement the new accounting. Deloitte & Touche LLP on March 18 said 21 percent of companies it surveyed were “prepared” for the standard.

The new guidance is not considered to be especially complex in terms of recognition or measurement. The standard requires companies to record on their balance sheets assets and liabilities for the rights and obligations of renting real estate, equipment, and vehicles.

But because leasing is such a pervasive business practice, it affects many parts of an organization. Most companies keep close watch on big-ticket rentals such as real estate, but equipment leases may be more difficult to track down and enter into an accounting system. Rental agreements may be stashed in file drawers or they may not even say “lease” across the top of the contract, so the initial data gathering may be a daunting task.

Then, they have to get down to the nuances of the accounting.

“As soon as you get into any sort of modification of the lease or any sort of extension or contraction to the lease, there are decisions on how you want to account for it at as well that companies need to think about and apply differently across the entire portfolio,” said Alan Berkley, senior finance specialist at Aptitude Software Ltd., which provides lease accounting software. “That’s where they trip themselves up.”

In addition, there are questions in practice about what constitutes a lease. The standard says a lease is a contract or part of a contract that conveys the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. For some arrangements, this will require a judgment call.

Bell of KPMG gave the example of a company renting buildings at a large corporate office park. Part of the arrangement may include a shuttle bus between buildings. The contract may not specify the type of bus included, but the bus may have the company’s logo painted on the side. Depending on the specifics of the tenant’s arrangement with the property owner, the shuttle bus service may be a lease, he said. If a company determines that this is not a lease, it has to make sure it can prove it, he said.

“The effort is still going to be there, to evaluate whether or not it is a lease,” he said.

Companies also are wrestling with breaking down lease and nonlease components from rental contracts, such as the lease of a photocopier that includes a maintenance plan, said Anastasia Economos, partner in the financial accounting advisory services practice at Ernst & Young LLP.

The maintenance plan may be a variable payment based on how many copies run through the machine. Under the new standard, companies need to determine which part of the rental covers the lease of the asset itself and which part covers the maintenance and account for the two pieces separately.

“People just can’t wrap their heads around that,” Economos said.

The FASB does allow a break for companies to opt out of calculating a lease contract’s lease and nonlease components, but many businesses will forgo it because having a bigger leased asset will result in a bigger liability on their balance sheets, she said.

“When you have a greater asset, you have a greater risk of triggering impairment. You also run risk of triggering the finance lease” classification, she said. Under the new standard, finance leases have different income statement treatment compared to operating leases.

The FASB has heard questions from the public about the new standard, including calls to delay the effective date by a year. The board has said no to any delay, but it has offered some breaks to ease implementation. In January, it published an update to relieve oil-and-gas companies’ concerns about accounting for decades-old land easements. In January, the board issued a proposal offering easier transition to the new standard and breaks to landlords and other lessors about breaking down rental contracts into lease and non-lease components.

The board confirmed the first part of the plan, Proposed ASU No. 2018-200, on March 7. The board confirmed that companies can prospectively apply the new lease accounting requirements as opposed to recasting prior years’ results under the new accounting rules at the transition date. The board plans to debate the second part at its March 28 meeting. It would allow landlords and other lessors to avoid separating lease and nonlease pieces of a rental deal and accounting for the components separately. This is supposed to mirror the option the standard offers to lessees when they rent a piece of property or equipment.

While the FASB’s plan has been applauded by many companies, it does not magically erase all the work involved with applying the new standard. In the Deloitte poll, 27 percent of respondents said they expected to spend the same amount of time on implementation, even with the potential for relaxed provisions, and 32 percent said they did not know.

“It doesn’t shift the deadline, it doesn’t change the complexity of the accounting, and it doesn’t change the scope of what they have to do,” Aptitude’s Berkley said.

The FASB published the lease accounting standard after a decade of debate and a failed effort to converge U.S. GAAP’s lease accounting rules with international standards. The new standard is a response to years of complaints — and attention from the SEC — about companies taking advantage of U.S. GAAP to keep debts off their balance sheets.

The current lease standard only requires companies to record lease obligations on their balance sheets when the arrangements are similar to financing transactions, such as rent-to-own contracts for buildings or vehicles. Few get recorded because of so-called “bright lines” in the literature that allow companies to structure deals as simple rentals. Planes, for example, are a key piece — and a major expense — of an airline’s business but if an airline leased the planes, they would not be on the company’s balance sheet, where investors and analysts could easily see the obligations associated with them, critics said.

Analysts and investors have long performed their own calculations to estimate a company’s lease obligations to get a better look at its financial health. When the standard goes into effect, it is expected to make balance sheets grow.

For in-depth analysis of the FASB’s standard for lease accounting, please see Catalyst: US GAAP — Leases , also on Checkpoint.

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