And they’re off! Like a day at the races, preparers and auditors – as well as business managers − are clamoring to digest the new standard on Leases (Topic 842) in the official “rulebook” of U.S. Generally Accepted Accounting Principles, the Accounting Standards Codification. The Financial Accounting Standards Board has officially opened the implementation gate by releasing the game-changing new standard.
Potential impactThe leasing standard is substantial, not only in sheer size (485 pages) but also in the potential impact on financial statements, particularly for lessees, who will now be required to place all leases − with terms in excess of 12 months − on the balance sheet. (Previously, lessees evaluated whether a lease would be placed on the balance sheet as a capital lease, or recorded off-balance-sheet as an operating lease, based on applying a set of factors.)
Lessors may also be significantly impacted under the new standard if the changes to the accounting model for lessees translates into an economic impact for lessees (e.g. by impacting the ability to raise capital due to changes in lessee’s leverage ratio or other key ratios).
How likely is it that the leasing industry will be impacted? Although the aggregate amount of leased assets moving to balance sheets has been reported by the Wall Street Journal and Lease Accelerator to be in the trillions, some have argued that the impact could be minimal, since sophisticated investors and analysts have been able to impute the impact of leases on a pro forma basis, using information on lease obligations disclosed in the footnotes to the financial statements. An early report issued by Lease Accelerator, titled Who is Most Impacted by the New Lease Accounting Standards, hedges somewhat, stating:
“Most experts on the new lease accounting standards believe that the majority of companies will not change their leasing behaviors. Accounting treatment is just one of many benefits of leasing. Of course, that does not rule out the possibility that there could be a few surprises.”
FASB effective date; SEC reporting requirementsThe Lease Accelerator report also points out that the effective date of the new leasing standard, for all intents and purposes, can be viewed two years earlier than the stated effective date of 2019 for public companies (2020 for all other entities), due to requirements of the Securities and Exchange Commission that public companies provide three years of comparable income statement data and two years of comparable balance sheet data. The FASB permits a “modified retrospective” transition approach and offers certain “practical expedients” to apply at initial adoption. Nonetheless, companies will want to gear up to capture information, even if retroactively, and ideally on a current basis as soon as practicable, to enable comparative reporting when the first published financial statements are required in 2019 for public companies.
Another consideration coming into play ahead of the effective date of the new standard, is the SEC’s requirement under Staff Accounting Bulletin No. 74, Disclosure Of The Impact That Recently Issued Accounting Standards Will Have On The Financial Statements Of The Registrant When Adopted In A Future Period. SEC Deputy Chief Accountant Wes Bricker reminded registrants of this obligation when he concluded remarks on another of FASB’s major new standards, the new standard on revenue recognition, Revenue from Contracts (Topic 606) (as amended by deferral of effective date to 2018 for public companies, and 2017 for private companies).
“As companies prepare their annual financial statements over the next couple of months, we are looking forward to reviewing more detailed disclosures about the expected effect the new standard will have on those financial statements [Footnote 9 referencing SAB 74],” Bricker said. “If that effect is still unknown, then in addition to making a statement to that effect, a registrant may consider advising investors when that assessment is expected to be completed. Again, this is about providing useful information to investors who need time to analyze the impact on companies.
Another responsibility when implementing a new accounting standard is to gauge the impact on, and update as appropriate, internal controls over financial reporting. SEC Deputy Chief Accountant Brian Croteau provided a reminder on this point, in his remarks at the AICPA’s December conference.
“It is important to give ongoing consideration to implementing or redesigning controls as necessary in connection with the application of new accounting standards and policies,” Croteau said. “Such changes in accounting have the potential to significantly impact many important areas of financial reporting. Management’s ability to successfully transition to new accounting standards will depend, to a large degree, on the effective design and operation of ICFR. I’d also remind management to consider its quarterly obligations to disclose material changes to ICFR, including in situations where such changes are made in advance of the adoption of a new standard, but also impact current period financial reporting.
The top three things to do nowRecognizing the depth and breadth of the implementation exercise on FASB’s new leasing standard, we asked leasing experts what the top three things are that companies should do now.
From Kimber Bascom, KPMG’s global leasing standards leader:
“Organizations should first ensure their pertinent accounting, finance, and operating personnel receive training around the new requirements so they can assess the impacts of the new standard on their existing and prospective lease agreements. Executives may wish to renegotiate the terms of some existing leases or take a different approach to the structuring of future leases. They also may want to rethink some lease-versus-buy decisions, and a sound understanding of the new standard’s requirements is essential for those purposes.”
From Dean Bell, KPMG’s new leases standard implementation lead partner:
“Secondly, having a complete repository of lease data is paramount to successfully apply the new guidance. To collect that data, organizations will need to develop a complete inventory of their existing leases. It’s critical to get an early start on that process. Securing executive sponsorship of the plan for data collection is key.”
From both Bell and Bascom:
“The third thing that companies should focus on is identifying which of their existing leases will continue to be considered leases under the new guidance and analyze the implications of the new standard’s requirements on existing systems, processes, and controls for those transactions. Involving a cross-functional team comprised of leaders from throughout the organization will help with the timely identification of the effects on financial statements, and internal processes and controls. Some organizations may want to consider adopting the new leasing and revenue recognition standards at the same time, through a single adoption process, since there may be synergies in doing so.”
Additional information can be found in KPMG’s Defining Issues, FASB Balloons Balance Sheet with New Lease Accounting Standard.