The SEC has made it clear – a deferral of the effective date of ASC 842, Leases, is not happening. With that reality in mind and the effective date for calendar year-end public companies upon us, are you ready? Based on our extensive experience implementing the new lease guidance for companies of all sizes, the following key readiness topics should be top of mind:

Robust SAB 74 Disclosures

The SEC will focus on SAB 74 disclosures regarding the implementation of ASC 842. As such, auditors will expect to see some level of quantification of the balance sheet impact as of the date of adoption. While many companies have been working to compile this data for months and test system outputs, some uncertainty remains about the ability to produce an exact amount by the time the 10-K is filed. As a result, companies should discuss with their auditor and audit committee the possibility of disclosing a range of the lease obligation. With challenges to implementation timelines, prudent adopters are also preparing for a “non-system” Plan B to meet their disclosure requirements, which may be extremely manual and labor intensive, but also necessary.

Complete Data and Documentation

Knowing auditors will not only test the application of the standard but also the completeness of leases, companies should take steps to ensure documentation of their approach is well organized and detailed. Completeness and accuracy of the historic lease population can have a significant impact on the opening balance calculations. Documentation of key accounting policy elections, significant judgments, and technical accounting conclusions reached in the adoption of the lease standard should also be reviewed in preparation for audit scrutiny.  A common document used during thoughtful implementations is an “assumptions guide” which outlines both minor and major decisions made by management throughout the adoption process. This guide will serve as a roadmap for auditors as they prepare for and perform their testing.

Processes, Processes, Processes

The importance of sound processes cannot be overemphasized. Consider the following four key areas:

1. Recording lease system outputs: Whether a company has implemented a lease accounting system or is recording leases manually from spreadsheets, the procedures to validate and review the lease journal entries will be critical to getting the balance sheet right. Considering that most companies have limited opportunity to execute a “dry run” of recording the lease accounting entries, a critical review of the process will be key in the first month-end close that the new lease standard is applied.
2. Developing lease disclosures: The new lease disclosures require data not previously captured or calculated like short-term lease cost, weighted average remaining lease term and weighted average discount rate. The process for building these disclosures should carefully consider what data will be needed, and if new accounts are required for tracking purposes. Companies should begin that process early to avoid last minute fire drills that may result in incomplete or inaccurate disclosures. If possible, reconciling disclosures amounts to system financial reports will provide evidence of accuracy and identify.
3. Validating system outputs: As many companies have implemented a lease accounting system, processes for validating the accounting output of that system will be essential to successfully adopting the standard. Companies should review applicable SOC 1 or SOC 2 reports for key user controls as well as perform manual validations over a range of scenarios to identify potential system bugs and needed workarounds. This same validation process may also apply to the development of disclosure data. Common use cases tested for validation include agreements with embedded leases, lease incentives, initial direct costs, rent free periods, index-based escalations, residual guarantees and reasonably certain options.
4. Operational processes: Even beyond the financial reporting considerations, companies should determine if operational processes need to be redesigned to ensure compliance with the new accounting standard. When making these changes, a phased implementation could be the most suitable approach, focusing first on processes critical to compliance and then on those which yield operational efficiencies. Also, keep in mind the benefits of enhanced operational discipline around leases such as cost savings, more consistent terms and conditions, greater data visibility and increased resource optimization.

Adopting the new lease standard will be a challenge for many companies, but with the right approach companies can successfully prepare for and execute this significant accounting and financial reporting change. The window is shrinking, and many companies will have to prioritize the tasks necessary to ensure compliance and improve the management of their leased asset portfolio. Riveron has deep experience guiding clients through this very critical change.