Top 10 lessons learned on the road to FASB/IASB lease accounting compliance

For many organizations, adopting and complying with the new FASB ASC 842 and IASB IFRS 16 guidelines has been one of their biggest challenges. For others it still is. Many of MRI Software’s Manhattan Lease Management Software clients have already finished implementing their systems for accounting compliance or are in the process of going live. We’ve seen close up, all the challenges they didn’t anticipate at the outset, and the lessons many of them have learned while undertaking this task.

Here are 10 of the biggest lessons we’ve learned from these companies

1. It’s a long and winding road

With the new regulations placing greater demands on the capabilities of accounting technology, many companies found their existing lease accounting systems needed to be updated or replaced altogether. Extra lead time was required to implement a system capable of identifying, compiling, processing and analyzing the important lease data an accounting and finance department needs under the new standards.

Many companies underestimated the amount of time required from both a systems perspective and an update of their operational and internal controls. In most cases, their timeline was severely affected by limited resources and ongoing pressure from their business needs.

2. The compliance team must be cross-functional

Many organizations thought the journey to compliance would be limited to their lease accounting and corporate real estate (CRE) teams. It’s now clear that key people from multiple business functions need to identify possible impacts of the guidance.

The right team to oversee your leasing transformation should therefore include specialists from corporate real estate, accounting, financial planning and analysis, financial reporting, internal audit, tax, IT, legal, procurement, and human resources. Treasury should also be involved because of the potential impact on financial ratios and debt covenant compliance.

3. Appoint an ‘executive champion’ for the project

Identifying and thoroughly evaluating the impact of the guidance to all functional departments has proved to be one of the biggest challenges so far. Some companies underestimated the additional company-wide workload that this requires.

It’s vital to make ensure the people you assign to the project can devote sufficient time to make it a success. After all, their work on lease compliance may be in addition to the time they spend on their ‘day job’. The project could drift if people give priority to other demands on their time.

One way of avoiding this is to appoint a senior level executive as the Project’s ‘Champion’; someone who has enough clout within the organization to drive the project forward. They must make sure sufficient resources are made available, host regular meetings to plan and review progress, and maintain a communication channel with the C-Suite.

4. Are you sure you have ALL your lease data?

It’s essential to ensure all your leases are properly identified and reviewed at the earliest possible stage. Many companies start out believing they had all their lease data on hand, only to find that a number of leases had not been fully abstracted.

In some cases, the information required to calculate the lease NPV and ROU had never been captured, or the fair market value and discount rate had not been documented. In other situations, data from ‘hidden’ leases—such as those embedded in service contracts—had not been properly identified. Leases that were exempt from the new standards—such as short-term or low value leases—had not been identified.

According to a PwC survey, 60% of companies reported experiencing difficulties in identifying their complete lease population. In many cases, data needed to be collected from thousands of leases and related documents—such as amendments, schedules, and asset listings—and the process required a multi-departmental effort spanning several months. Certain lease information was often found to be missing or, in the case of decentralized operations, there were significant gaps because some leases were held by subsidiaries.

Companies that operate in multiple countries have learned to tread carefully when it comes to extracting data from international leases which contain non-standard periods or are written in the local language. Foreign language leases may contain terms and conditions that are included only by inference. It’s important to have the leases professionally translated and documented to ensure the new standards are adopted correctly.

5. To be (a lease), or not to be (a lease): that is the question

To properly manage compliance, all leases need to be captured in your system. There may be many out there that don’t look like leases or there could be some you don’t even know you’re looking for to ensure completeness. A simple way of trying to spot unidentified embedded leases is to scour your AP Register. If you see a recurring payment, that is the same amount every month, you should take a close look at it.

Companies need to carefully analyze arrangements that are not typically thought of as leases, such as outsourced warehousing, data management, data centers, supply agreements or service contracts. These may be subject to the new rules, and therefore require additional scrutiny and possible capitalization.

A lease may not be readily identifiable as such if it’s embedded in a service contract. There may be an embedded lease within the service contract which requires bifurcation to be recorded on your balance sheet.

6. Time for a policy and procedure makeover?

If you’re implementing new technology to help ensure full compliance with the new standards, it may be a good time to also review your internal policies, procedures and control processes from a SOX perspective and maybe consider giving them a makeover.

Challenging some of the old controls and procedures you’ve been following for years might yield real benefits by modifying those controls to be more efficient as well as effective. You’ll need to determine what changes should be made and who will manage them post implementation.

7. Managing change

Your approach to lease accounting and financial reporting will never be the same again under the new rules, and your team may no longer be able to handle leases in the same way. Your old methods just won’t be capable of compiling, processing and analyzing all the important lease data that the finance department now requires on a timely basis. So things have to change.

Because people are often apprehensive about change, a shift to new processes means some form of change management program may be necessary. You’ll need to put someone in charge who can inspire people to buy into the changes by showing how the new way of doing things will make their jobs easier and better.

8. Know your limitations

The FASB/IASB transition and final adoption periods present complex challenges—not the least of which is understanding the various transition options and the timing dependencies of each. Both the FASB and IASB boards are good at telling companies what to do, but they’re not so good at telling you how to do it. That’s why our advice is: know your limitations. Accept that you might have to seek outside support and get it.

If you find yourself in a situation where you’re not sure how to interpret one of the standards, talk to your independent auditor before making a move. Your auditors always need to understand and agree with your determinations. If they don’t agree with your approach, you may end up with a difficult year-end audit if you just go ahead and implement your interpretation anyway!

9. Underestimating the cost of compliance

Many companies set out on the road to compliance without a clear idea of how much it would cost to implement the new standards. Without thinking broadly enough about the range of stakeholders at the outset, they failed to budget realistically for their overall internal and external implementation costs.

New software, the need for additional resources and training, and the amount of extra management time spent collating lease data all contributed to higher than expected costs. Companies also underestimated the external costs involved—such as having to rely on their auditors for advice and using the services of other outside contractors.  As the saying goes…you only get what you pay for!

10. Allow enough time for robust testing

Because user test scenarios included in UAT vary from company to company, it’s important to recognize that your system provider won’t be able to do the robust user acceptance testing for you. It is advisable to allow at least three months to do proper testing.

You should start by thinking through what you need to test from a corporate reporting and compliance standpoint. Make sure you have documented test scripts for each unique scenario (such as non-standard period leases, additional ROU adjustments and renewal options exercised). And you must be able to perform the calculations outside of the system (possibly with the help of Microsoft Excel) in order to validate the process.

The new lease accounting standards impose a much heavier reporting burden, so it’s vital to thoroughly test your system to make sure you can quickly and easily produce accurate and audit friendly/verifiable reports.

Thank you for reading MRI Software’s top 10 lessons learned on the road to FASB/IASB Lease Accounting Compliance. If your organization is looking for a technology partner to help meet your lease administration, accounting and reporting needs, we’re here to help.