Prepare-for-looming-lease-accounting

Preparing for the Looming Changes in Lease Accounting

A Technological Solution for the Informational Problem

By Dennis Chambers, James Dooley, and Catherin A. Finger

(Excerpts from the article published originally by The CPA Journal January 2015)

The purpose of this article is to help lessees that have extensive operating lease portfolios reduce the uncertainty related to preparing for new lease standards before the final revised lease standards are released.

Problem

Most companies with large portfolios of operating leases do not have ready access to the lease contract information they will need for reporting under the new standard—nor do they have that information in an electronic form that will maximize its usefulness. Second, lease negotiation and management is often done at the division level or lower; as a result, lease-specific information may be maintained at the lease origination point (instead of centrally) using spreadsheets that are housed on individual computers.  What is more, that information tends to be limited to that which is necessary to prepare aggregated totals.

Additionally, information about the underlying leased asset is also central to recognition decisions, and is not currently part of the information retained by most companies in searchable or electronic form. The lack of complete, useable information about operating leases will cause significant problems.

Challenge

In order to meet the new reporting requirements, companies with large operating lease portfolios will have to convert their incomplete, decentralized lease recordkeeping into an information system that contains complete information about the terms in each lease, makes the information available centrally, and enables the information to be used for analytical and predictive decision models. In addition, the lease information system will need to meet the internal control standards that chief financial officers will impose to guarantee the accuracy of the balance sheet.

Assembling complete lease information will be time consuming, labor intensive and will result in many companies needing to go back and “reabstract” their operating lease documents.  Because the transition to the new lease standard will require restated financial statements for two or three years prior to the effective date, the lease data for prior years will have to be included in the lease abstraction and data conversion.  To read more about the challenges associated with the new lease administration procedures, staffing and data-gathering, click here.

Opportunities

Although the transition to the new leasing standard presents significant challenges, there are also significant opportunities to leverage the increased availability and usefulness of lease information in order to improve outcomes and provide value-added services to corporate decision makers.

The decentralized maintenance of lease information has led to significant variations within a company, event in the treatment of similar leases. Bringing all lease information into a centrally designed and maintained information system can be used to enforce more consistent treatment across the entire organization.  Additionally, having a complete lease information system in place well before the new lease standard takes effect will provide useful data for current lease negotiations.

Furthermore, an accurate and reliable information system for leases will provide opportunities to improve operations and cost-control efforts. Managers can use the data to make operations more efficient; for example, verifying the data for every lease will ensure that data entry errors are not costing the company money due to overpayments.  After the standards change, non-real estate leases are likely to become more significant and will need to be managed more carefully and accurately.  The availability of detailed and accurate information about these leases will make it possible to improve the management and monitoring of leases and lease policies.

Solution

The solution to the problems and challenges discussed previously will involve a new software implementation to collect, house and manage lease information. Ken Tysiac (“Taking Stock of Leases,” Journal of Accountancy, November 2013, p.18) briefly describes some tips for transitioning to a centralized information system for leases based upon the experience of Judy Ryan, who led the implementation of such a system and Johnson & Johnson.  The system should be able to:

  • Incorporate information about all types of leases
  • Be accessible throughout the organization
  • Be accessible and user-friendly for decision makers

The software solution must be able to:

  • Do the calculations necessary for reporting and operational purposes
  • Incorporate lease changes
  • Archive the assumptions, data, and calculation
  • Perform a “what if” analysis needed by managers, lenders, and other stakeholders
  • Allow the use of profiles to record and maintain data for similar leases and be able to override profiles

Companies must also decide which data items to collect and include in the new lease information system—a crucial stem in the process. The data collected and maintained in the lease information system should be comprehensive and adaptable.

Facing the Unknown

Companies should start preparing for the new leasing standard now in order to fully understand what they will need to do, determine how long it will take, and start doing it. From the beginning of the process, there has been little debate about whether operating lease assets and liabilities would be shown on the balance sheet: they will be.  Thus, no matter what form the standard takes, companies will need a complete lease inventory and a comprehensive lease database.  The availability of comprehensive lease information will significantly advance a company’s preparedness for whatever accounting changes are eventually adopted.  In addition, preparing for the new standard also will yield other important value-added benefits.

Interested in reading more? Download the full PDF article here.