Lease accounting implementation and post-compliance insights for public and private companies

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Whether your company is public or private, the new lease accounting standard, ASC 842, remains an important issue. For most public companies, the adoption deadline has passed, and the focus is now on quarterly reporting under the new standard. Having implemented the minimum requirements to meet the deadline, many public companies may now find they need a more fulsome approach that meets compliance needs while also creating efficiencies for accounting and other systems.

By contrast, many private companies and non-calendar year-end public companies are just gearing up or are still at work adopting ASC 842. While they have plenty of work ahead, private companies can benefit from the many lessons learned from public companies’ implementation experience.

Below we offer implementation insights for companies still approaching their ASC 842 effective date, as well as considerations for companies that have moved past their compliance deadline.

Use the index at right to navigate to the different sections.

ASC 842 effective date

Day 2 challenges — and insights — for public companies

Systems

With the demands of quarterly financial statement reporting, some public companies may find that the systems they chose are unable to produce all the needed accounting entries, disclosures, or management reporting. If your team is booking entries manually or patching interfaces, further integration and optimization of your lease accounting system and the processes around it will greatly facilitate a more efficient and well controlled compliance process going forward.

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Accounts payable system integration

In the race to implement, many companies may have postponed integration of their accounts payable system with the new enterprise lease accounting system. Now that compliance is achieved, efficiency gains such as enabling seamless data transfer from leasing invoices and disbursements between systems should be reviewed.

Companies will need to examine their processes for generating payment schedules and facilitate an interface between any outsourced accounts payable functions and the new lease system. Consider how this will work operationally — through a centrally managed function or more of a distributed model. Some organizations have also gone a step further to consider how they want their lease management processes to integrate with overall contract management (see “Contract management improvements,” at left).

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Software updates and regression testing

Enhancing enterprise lease accounting systems is proving challenging. With a wide-ranging new standard and a pressured adoption time frame, many systems are still evolving and may require frequent updates. Keeping up with system patches while remaining in compliance may require a combined business and IT strategy that balances frequent patch releases, extensive testing, and business operations.

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Controls

For many, the laser focus on adoption relegated controls to the back burner. But effective risk management requires the right controls and processes in areas such as:

  • Product documentation
  • System access
  • Accuracy and completeness of data extraction and testing
  • Systematic controls / configurable controls

Organizations that have not already discussed the new leasing standard with their auditors will want to address any questions about controls early, especially with regard to new systems. Companies may also want to undertake a controls assessment of the entire leasing environment, including a close look at automated versus manual controls (see “automating processes,” below) and system implementation controls.

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Lease extraction

Extraction of key data from lease agreements needed for ASC 842 reporting remains a challenge as companies sign new leases and modify current agreements. Many companies lack the in-house resources to design and implement ongoing processes for loading new leasing data into their systems. Companies will want to assess whether this resource-intensive effort is best performed in-house or with outside expertise, leveraging technology tools to help accelerate and automate the process.

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Lease management improvements

In general, the new standard has ushered in more centralization, including greater collaboration among real estate, procurement, and accounting functions. Increased visibility into lease portfolios is helping many companies renegotiate embedded interest rates for equipment leases and more accurately determine whether a lease even makes sense, among other savings.

With lease liabilities now on the balance sheet, visibility has extended to the external markets, increasing the stakes for better lease management. For more on this topic, see “Improvement opportunities,” below.

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Contract management improvements

Looking beyond leases, the adoption effort revealed that for many companies, centralized access to all sorts of contracts—leases, revenue contracts, vendor contracts, and many more—is typically rare. These siloes can lead to missed opportunities to leverage customer incentives or vendor rebates. For example, evergreen contracts that automatically renew could result in overpaying if no one is monitoring the terms closely enough. One of the important lessons learned from lease accounting implementation is that systemized contract management can reveal important business opportunities that had previously been overlooked.

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Consider automating repeatable lease processes

Accounting under ASC 842 is likely to require designing new processes to gather data needed for reporting new leases. Many of these processes will be built from the ground up and will involve tasks that need to be repeated for each new lease.

You can increase efficiency by using Robotic Process Automation (RPA) to create programs (called “bots”) to automatically complete repetitive lease accounting tasks. At the same time that you are creating new processes, consider using RPA to save time and money and increase accuracy over relying on manual processes for new reporting required under ASC 842.

ASC 842 insights

Post-implementation accounting issues

Having addressed the transition-related accounting issues, companies will need to shift focus to the ongoing accounting requirements of the new leases standard, many of which differ from prior accounting. Consider these post-implementation accounting issues faced by many companies;

Lease identification

As companies observed during the transition process, contracts not traditionally thought of as leases may be in the scope of the new guidance. Companies will therefore need to monitor new contracts on an ongoing basis to determine if they are in scope of the standard. This may require new processes, as well as raising awareness within other business functions, such as procurement or corporate development. Judgment may also be necessary to determine whether certain contracts, such as outsourced warehousing,data management, and supply arrangements require capitalization.

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Remeasurement events

In certain situations a lessee may be required to remeasure its liability and adjust its lease asset, as well as reconsider allocation and classification. A lessee should monitor any events that may change its initial determination around whether it would exercise lease extension, termination, or purchase options. Examples may include significant leasehold improvements or significant modifications to the underlying asset.

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Impairment

A lessee’s right-of-use asset is subject to the same asset impairment guidance in ASC 360 applied to other elements of property, plant, and equipment. This will be a significant change to current practice, and application may vary based on facts and circumstances. Further, once a right of use asset associated with an operating lease is impaired, lease expense will no longer be recognized on a straight-line basis demanding a change to the expense calculation process.

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Sale-leaseback

In a sale-leaseback transaction, new guidance requires that both the seller-lessee and buyer-lessor evaluate whether a sale in fact occurred from an accounting perspective. This assessment, which is less prescriptive than legacy guidance, and now includes the lessor, is predicated on whether there was a transfer of control. While certain terms may preclude asserting control was transferred, such as where a lessee holds a fixed-price purchase option on the underlying asset, the impact of other terms may require judgment (i.e., fair-value purchase option).

In light of the judgment required, some companies may prefer, where possible, not to take title to an asset they intend to lease. Having said that, even where a lessee does not take title to the asset, if it obtains a fixed-price purchase option, it may still need to consider if it substantively obtained control over the asset.

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Build-to-suit

Where a lessee is involved in the construction or design of an underlying asset prior to lease commencement, both the lessee and lessor will need to evaluate whether the lessee obtained control of the asset during the construction period, which may require significant judgment. Under prior guidance only the lessee considered specific build-to-suit guidance. If a lessee does obtain control, it would view the transaction as a financing arrangement rather than a lease.

A lessee and lessor would then need to determine when, if ever, control transfers from the lessee to the lessor and qualifies as a sale and a leaseback. This might occur after the construction period is complete.

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Implementation insights for private companies

For private calendar year-end companies, the ASC 842 implementation deadline is January 1, 2020. Although that may feel like plenty of time, most companies should be getting started now. Implementing the new leasing standard is time- and resource-intensive. The level of effort required for private companies will vary greatly, reflecting differences in size, operating models, and number of leases. Moreover, compliance doesn’t end once you meet the deadline.

As public companies are now finding, additional work is needed to remain in compliance on Day 2 and beyond. By frontloading, keeping Day 2 in mind, and leveraging lessons from public companies’ implementation experience, 2020 adopters can significantly facilitate both adoption and Day 2 compliance. In addition to the guidance summarized below, private companies may want to review the additional insights previously offered to public companies, as they were approaching their compliance deadline.

Leasing implementation overview

Involve a broad range of stakeholders early and often

Recognizing the breadth of ASC 842’s impact is essential. By giving a wide range of stakeholders a seat at the leasing transformation table, organizations can drive realistic budgeting for overall implementation costs, effective coordination, and crucial troubleshooting. Key players may include:

Finance

With most existing and new leases headed on to the balance sheet under the new standard, financial reporting, budgeting, and forecasting need to be ready for new disclosures, depending on your company’s reporting practices. Consider whether additional transaction processing and/or controls will require increasing headcount, utilizing a Center of Excellence, or deploying Robotic Process Automation

IT

Approach leasing system implementation like any other major IT effort — with rigor, discipline, and expertise.

Tax

To address the new standard’s wide-ranging impact on tax compliance and planning, coordinate early and often with your tax function. Due to the parallel system of accounting for leases under the Internal Revenue Code, ensuring tax departments are a key stakeholder in the adoption process is recommended. Consider the impact new book systems and processes will have on historical tax processes and determine path forward for redesign and/or solutions to assist with lease tax reporting prospectively. See below for more on tax considerations.

Procurement

Lease vs. buy decisions may need a fresh look once they are no longer subject to off-balance-sheet financing. Reassessing procurement and approval policies will facilitate the collection and standardization of lease data for reporting.

Treasury

It’s worth focusing on debt covenant compliance, especially as new debt agreements are renegotiated prior to the effective date. Treasury should also weigh in on the lease vs. buy analysis.

Auditors

Both internal and external auditors have important roles to play during ASC 842 adoption. Internal audit expertise can help design controls for transitioning to the new standard and post-compliance reporting. Sharing transition plans with external auditors can help avoid surprises during the first audit following ASC 842 adoption.

Real estate and facilities

If the new standard causes purchases to increase and leases to decrease, the existing asset lifecycle management process may need to be changed.


Lease data and system implementation issues

Data gathering and extraction

When it comes to data preparation, the time is now. Start with a survey of existing leases (plus related documents like amendments, schedules, and asset listings) and business requirements, and determine how complete your data is.

Remember to include arrangements that did not previously qualify as leases, but that now fall within the scope of the new guidance. This initial assessment could be very resource-intensive if you are missing data or leases (for example, those housed at a subsidiary), or need to convert quantities of hard copies.

Many public companies turned to technology solutions to accelerate lease abstraction and reduce errors. Depending on your level of reporting, you may need to consider if an auditor can understand your approach to data gathering and extraction.

Lease accounting insights

System selection

Choosing an optimal lease management system is essential. Initially, think through whether your organization needs end-to-end lease management, accounting, and standardized reporting, or whether more limited functionality is a better fit. Take the time to define system requirements, based on the type of lease data your stakeholders will rely on to enable effective lease reporting and management.

In some cases, traditional spreadsheets may suffice to meet the deadline, but an effective implementation of ASC 842 will frankly assess future needs. And remember to keep all stakeholders in mind, including tax personnel— many lease management systems are not designed to produce tax reporting.

You may also want to consider which broader system integrations, processes, and controls are needed for your compliance and planning functions to run efficiently on Day 2 and beyond. Fortunately, private companies will be implementing systems that are one year more mature than those selected by their public counterparts.

System selection

System testing

Testing is not the place to cut corners. Data migration, regression testing, user acceptance testing, and training are all crucial components of your implementation. A system that doesn’t produce accurate and verifiable reports won’t do you much good, so ensure your team takes the time to test for defects and failures that may inhibit reporting.

Remember that you are not working from a blank slate — leverage the experience of public companies, which have already persevered through this process. For example, when testing use cases, keep in mind that most have already been tested, and expertise exists about how to troubleshoot initial hurdles.

System testing

Implementation accounting issues

Certain accounting issues proved particularly challenging during public company implementation. Private companies will want to take a close look at the following areas:

Lease identification

The new guidance casts a wide net, requiring companies to consider arrangements beyond typical leases. Careful analysis and judgment may be needed to determine whether areas like outsourced warehousing, data management, and supply arrangements require capitalization.

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Incremental borrowing rate (IBR)

Under new guidance, private companies are afforded a simplified approach to determining IBR, and may use a risk-free rate for a period comparable to the lease term. While significantly less effort than what is required for public companies, private companies will still require processes to calculate lease liabilities using the appropriate rate.

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Payments

Calculating the lease liability involves judgment calls about whether to include renewal periods or to consider purchase and termination options. Additional data about lease payments (for example, whether they are fixed or variable) may be needed. Depending on a company’s elections, allocation between lease and non-lease payments may be necessary.

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Policy elections

The FASB permits companies to make elections that may facilitate the transition to the new standard and its application. For example, companies can choose to:

  • Carry forward previous lease classifications
  • Decline to push back application for comparative periods presented
  • Combine lease and non-lease components.

Some of these elections must be chosen as a package, and private companies need to consider the broader impact of these expedients.

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Increased disclosure requirements

Depending on your company’s approach to reporting, the new standard creates expanded qualitative and quantitative disclosures, with the goal of increasing transparency around revenues and expenses recognized, and expected to be recognized, from existing contracts. These disclosures require significant judgment by management, and companies will want to plan how they will gather the necessary information and communicate with relevant stakeholders.

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Transition impairment

Companies may find that the interaction between recognition of a lease asset, on the one hand, and prior impairments and lease exit costs, on the other, impacts their transition and reporting when they adopt the new standard. Companies should look out for previous unrecognized impairments that may need to be recognized at adoption, prior exit costs that might result in front-loaded expenses at adoption, and prior exit costs that may require separate accounting because they exceed the lease asset.

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Important tax considerations during ASC 842 adoption and beyond

The parallel system of accounting required under the Internal Revenue Code for lease contracts should not be forgotten during the adoption process. Although tax law dictating lease classification and expense deductibility have not changed, the transition to new book general ledger accounts and sub-ledger (i.e. lease accounting management system) data sources will require attention by the tax function in order to simply recompute deferred taxes prior to the new standard. Early coordination with the tax function to consider their requirements for data and reporting will help support financial reporting and tax compliance and planning, while enhancing the overall efficiency of the adoption process.

New risks and opportunities exist as a result of the 2017 tax reform act. Notably, the importance of lease classification decisions for income tax purposes, due to full expensing and interest expense deductibility limitations, has never been more relevant. Additionally, many of the new international provisions introduced under the 2017 tax reform act have lease accounting considerations that should be assessed in the context of tax ownership of assets for Qualified Business Asset Investment and cross border asset transfers. These include:

  • Global Intangible Low Tax Income
  • Foreign-Derived Intangible Income
  • Base Erosion Anti-abuse Tax         

The new guidelines may also affect indirect tax processes and data flows (e.g. sales and use tax, VAT, GST, etc.) and proper attention should be paid to these impacted areas.

Finally, book lease accounting management systems generally do not have tax reporting functionality designed within them and therefore new processes and data reports will be needed to appropriately tax account for the lease portfolio. Automation opportunities should be evaluated from the onset of adoption to implement efficient and risk-mitigating processes for financial reporting and tax compliance.

ASC 842 tax considerations

Improvement opportunities for both private and public companies

Although adopting the new standard poses many challenges, it also creates potential benefits, including improved standardization, centralization, and automation. For private companies looking to optimize their adoption efforts and for public companies seeking improvements now that the deadline crunch is past, we suggest a closer look at opportunities, including:

Centralization

With procurement departments likely to become more directly involved in enterprise-wide lease negotiation, companies can increasingly centralize lease data. This effort can boost consistency and cost-savings through analysis of lessor terms and conditions.

Check the expiration date

Companies may want to consider their ability to reduce or eliminate cost leakage from expired leases.

Fine-tune lease vs. buy

By incorporating controls and defining when lease vs. buy models should be used, companies can potentially reduce costs and optimize tax impacts.

Leverage available tax benefits

Revised tax rates and full expensing, both products of tax reform, can lead to savings. Companies should also consider tax planning opportunities around state sales and income tax, as well as foreign-derived intangible income.

How PwC can help

PwC offers public and private companies deep, integrated expertise in the range of areas impacted by adoption of the new lease accounting standards and post-compliance optimization. We can help analyze the impact on business models, and help evaluate and implement a wide range of solutions and processes. These include accounting, tax, systems, processes, and controls, to name a few. We look forward to discussing how we can help you navigate adoption and improve implementation under the new standard.

How PwC can help

Contact us

Dustin Osgood

Partner, Data and Process, PwC US

Sheri Wyatt

Partner, Accounting Advisory, PwC US

Tel: +1 (312) 298 2425

David Shebay

Partner, Finance and Systems, PwC US

Edward Tarka

Partner, Tax, PwC US

C.J. Finn

Partner, Private Company Services, PwC US

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