Updates in ASC 842 and IFRS 16 represent the most significant change in reporting standards in the past two decades. Literally trillions of dollars of lease transactions can no longer be kept off-balance sheets, ending the substantial level of guesswork involved in their calculation until now.
And while this represents a leap forward in the transparency and comparability of companies’ lease obligations, it also means a lot more work for the accounting profession.
Somewhat paradoxically, the lack of transparency that previously existed in lease accounting gave enterprise CFOs a degree of flexibility in calculating the value of a company’s lease obligations. A reasonable estimate was fine. Changes to ASC 842 and IFRS 16 mean that this is no longer the case. While before, operating leases were no more than a footnote in the financial statements, they now have to be individually calculated at their current value.
This in itself raises a range of issues:
The average financial executive has had no need to keep track of their company’s lease obligations, because they had no need to; it’s fair to assume that many aren’t even intimately familiar with the finer details of lease contracts.
An extension of the fact that companies haven’t needed to keep track of their leases is that they may not even know which assets are leased. This issue is likely to be accentuated by changes in staff within the financial team after the lease was signed.
The reality of embedded leases is that, even non-lease contracts can contain elements classified that can be technically classified as lease contracts, meaning that these also have to be reevaluated.
Valuation of some leases may require financial executives to choose a suitable discount rate. This will need to be based on a range of factors such as the term of the lease, the amount of debt on the balance sheet, the economic environment, and more.
What’s clear from these issues is that unless financial executives have a framework in place for implementing the required changes to the leasing accounting standard, they’ll be underwhelmed by them. And failure to comply brings with it the specter of increased audit costs, diminished investor confidence, and damaged reputation. Below are three steps that enterprise CFOs can take to accelerate their lease accounting projects.
Step 1: Conduct an Internal Lease Audit
For CFOs, the first step to implementing the changes to ASC 842 and IFRS 16 is to know where their companies’ leases are. This begins with an internal audit focused on leases. You need to know which pieces of equipment were leased, when they were leased, and under what terms. This includes looking at lines on the balance sheet that could include embedded leases, such as the company’s real estate assets.
Step 2: Create a System
The more leases a company has, the more important it is that a system is in place for recognizing those leases in the correct manner. This negates the need to reinvent the wheel every time that a lease contract begins, reducing the already considerable workload for the finance team. Putting in place a systematic approach to evaluation, for example, means that people have something to refer to when setting the discount rate for some leases.
Step 3: Utilize Lease Accounting Technology
A range of powerful tools have already appeared on the market to help CFOs in this endeavor. One such example is provided by Trullion. It uses a combination of artificial intelligence and machine learning to convert companies’ lease contracts into workflows. These workflows, when converted into reports, allow auditors to connect with the data source. Given that many lease contracts can take up to three hours for a finance team to process, this tool has the potential to generate significant savings for companies with multiple leases.
Conclusion
The scale of the impact of the new lease accounting standards cannot be overstated. Enterprise CFOs need to take active steps now to ensure that they can accelerate their lease accounting projects. In short, this means identifying all of the company’s lease obligations, creating a system for future proofing their lease obligations, and taking advantage of the extensive range of lease accounting tools available to them. By taking all three steps, private companies maximize their chances of being fully prepared when the new standards come into force on January 1, 2022.
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Here’s How Enterprise CFOs Can Accelerate Lease Accounting Projects
