Lease Accounting: Post ASC 842 Adoption Clean Up and Lessons Learned
This article first appeared in Financial Executives International
The first half of 2019 has been a busy time for companies that adopted the new lease accounting standard (ASC 842), but not for the reasons one might expect. As some public companies are beginning to celebrate Q1 filings under the new standard, many others are being hit with the reality that the work is far from over. And the reason is simple: in the rush to comply with ASC 842, few companies anticipated the ripple effect of clean-up activities that would emerge following adoption. Now, faced with a growing list of challenges, these companies are revisiting implementation activities and determining how to enact solutions for long-term success.
Industry experts believe that nearly 25 percent of companies failed to optimize their adoption of the new standard. This failure is due, in part, to companies not running pre-adoption checks and processes—a move that would have ensured the right mechanisms were in place to address Day 2 challenges. These companies now face onerous clean-up tasks, including recording a large volume of adjustments needed to ensure accurate financial reporting. Public companies can begin to tackle the laundry list of residual clean-up activities, while private companies (and late-reporting public ones) can incorporate lessons learned into a robust adoption plan.
The Clean Up
Among the clean-up activities that companies are now encountering is the investigation of reconciling differences identified during the first quarter of reporting following adoption. These differences may have resulted from the implementation effort in areas such as deferred rent and the clean-up can involve reconciling invoice payments to journal entries recorded under the new standard. These reconciliation procedures might lead to identifying lease amendments not previously considered, resulting in changes to inputs such as lease terms and end dates. Another area where companies can expect to spend time on Day 2 is the consideration of non-lease expenses, such as taxes, included in invoices and lease amounts which are not truly part of the lease liability.
In addition to reconciling activities, performing trend analysis, such as account grouping, cost center or business unit, ensures that the accounting structure of the new lease entries aligns with historic application. For many companies, a general ledger (GL) string was tagged to lease entries to correctly map into existing ERP systems. The analysis should include looking for any spikes or declines at transition by cost center or business unit to determine whether inconsistencies are a result of actual lease activity or incorrect mapping.
Along with payment reconciliations, many leases have variable rent expense components that are expensed as incurred under the new lease standard. Common variable rent expenses, such as CPI adjustments or lease productivity, can be maintained by separate divisions. Processes must be refined to establish communication channels between asset managers and accounting to ensure consistency between actual lease activity and recorded lease activity. For many, the result of these initial clean-up activities is the realization that manual reconciliations and calculations are now an ongoing requirement.
For companies using lease accounting systems, another factor to consider is the emergence of new functionality that was not ready at the time of initial implementation. Components of manual calculations initially done outside of the system often must be integrated into the new functionality. While these enhancements ultimately help the overall application of the standard, they may require user review and training, which can slow performance times as users learn the new features.
Throughout cleanup, planned processes may emerge that no longer provide their intended results. When this happens, companies must be nimble and pivot toward better-suited approaches.
Ensuring a Smooth Transition
As evidenced above, data cleansing and implementing the right strategies for long-term lease accounting management is crucial. As with other business transformation events, following common governance principles and utilizing a project management toolkit will help companies address the known and unknown changes they are likely to encounter. Among the steps that companies can do to ensure a smooth transition are:
- Reconcile system or manual calculations to what is recorded in the GL, ensuring that legacy balances (i.e., deferred rent) have been appropriately cleared.
- Regularly review the GL to ensure that inputs and calculations are continuing to be properly entered according to the new process.
- Identify the right people within the lease management cycle by utilizing subject matter experts in operations, IT, accounting and financial reporting for the appropriate business function.
- Create documentation with use cases for common scenarios encountered such as end-of-term events, payment adjustments and incremental borrowing rates (IBR) and foreign exchange updates.
- Stay on top of system updates and training by maintaining contact with the software provider or implementation partner as many systems are still perfecting technical functionality and user best practices.
- Anticipate audit inquiries by preparing documentation and support for high risk areas such as required company judgement, estimates and policy decisions.
- Continue to refine processes by building on lessons learned during data abstraction and implementation. Identify which information was difficult to receive or validate and build out controls and dependencies around those processes going forward.
Keys to Success
A key to ongoing success across all adoptions of the new lease standard is having a strong internal group comprised of operational and accounting subject matter experts who are involved throughout the entire pre- and post-adoption process. For companies beginning the adoption process, quantitative checks to historical data and consideration of future operations design should be performed in parallel with implementation phases. For those already accounting under the new standard, methodical clean up and decisive processes for the future will help create efficiencies for ongoing success.
The new lease accounting standards adoption process has had its share of foreseen and unforeseen challenges in Q1. As companies enter the second half of 2019, they will need to be diligent in reviewing their inputs under the new standard and implementing the right mechanisms to ensure they are not only remaining compliant but are overcoming inefficiencies and maintaining cost-effectiveness for the future.