6 minute read 5 Aug 2019
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How private companies can start implementing the new leases standard

By

US Americas

Multidisciplinary professional services organization

6 minute read 5 Aug 2019

The next significant accounting challenge for private companies will be implementing the new leases standard, which we expect to be effective for calendar year-end private companies in 2021.1 Start planning for the new leases standard now, as implementation often brings unexpected complexities.

One of the biggest changes is that Accounting Standards Codification (ASC) 842, Leases, requires lessees to record most operating leases on the balance sheet. While lessees with significant operating leases will be most affected, all lessees and lessors will have to make changes to their accounting policies and processes, and possibly to their information technology (IT) systems.

Implementing the standard will require the same sort of planning as implementing the new revenue standard. That is, private companies need to focus on understanding the new requirements and the effects on their financial statements, operations and communications with various stakeholders.

Based on our experience with companies that have adopted the new leases standard, implementing it often requires more effort than management initially anticipated. Many companies have experienced difficulty determining whether their lease population is complete, collecting the data they need to account for and disclose information about their leases under the new standard, and developing IT solutions to track the information and perform key calculations. Thus, it is important that you start planning now, even though the Financial Accounting Standards Board (FASB) has proposed a deferral of the effective date to give private companies more time to implement the standard.

This is the first in a series of articles to help private companies plan for a smooth transition to the new leases standard. Additional resources are also available on AccountingLink.

What you need to know

  • You should continue planning for the new leases standard, even though the FASB has proposed deferring the effective date for private companies, because implementation will likely require more time and resources than you expect. 
  • To get started, you need to understand the requirements of the new standard, establish a project team and prepare a project plan.
  • You will need to identify a complete population of leases, which is often one of the most challenging aspects of implementing the standard.
  • You will need to change your accounting policies and consider whether to make a number of policy elections, including whether to use several transition practical expedients.
  • Because the new standard requires companies to gather more data to account for and disclose information about their leases, you may need to implement an IT solution to track this information.
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Chapter #1

Draft your project plan

Implementing the new standard will likely require more effort and more resources than you think.

Implementing the new standard will likely require more effort and more resources than you think. Some areas that could make implementing the standard more or less complex include the following:

Draft your project plan

The first steps are understanding the requirements of the new leases standard, establishing a project team and preparing a project plan. An important consideration is assessing whether the company has sufficient and competent resources to effectively implement the standard or whether it will need to engage an advisor. It is also important to engage with internal stakeholders (e.g., IT, legal, lease procurement, business operations, tax) early in the process.

The table below lists activities you should consider as you develop your project plan for the key phases of the implementation.

Design and plan for Diagnostic phase
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Chapter #2

Understand your leases and identify a complete population of leases

Identifying a complete population of leases is one of the most challenging aspects of implementing the standard.

Identifying a complete population of leases is one of the most challenging aspects of implementing the standard. To start, you need to confirm your understanding of your current leasing activities and processes and consider whether you have operating leases embedded in service contracts or other arrangements.

This may be more complicated than you think. That is, you may not have robust processes in place to distinguish between leases and service contracts because, under the legacy guidance in ASC 840, Leases, the treatment of these arrangements is similar.

In addition, it may be challenging for a company that has a high volume of contracts and decentralized operations to make sure it has identified a complete population of leases. 

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Chapter #3

Develop new accounting policies

The new leases standard’s transition provisions are unique and complex.

The new leases standard’s transition provisions are unique and complex. You can choose to apply the transition provisions at the beginning of the earliest comparative period presented in your financial statements or you can apply them at the date of adoption (i.e., the effective date). The latter option effectively allows you to continue to apply the guidance in ASC 840, including its disclosure requirements, in the comparative periods and may make the transition accounting easier to apply because you would not need to recast numbers for periods before adoption.

Regardless of when you apply the transition provisions, you’ll likely apply concepts from both ASC 840 and ASC 842 to leases that existed before the effective date. As a result, you’ll need to develop two sets of policies — one to calculate your transition adjustments and to continue to account for leases that commenced before the effective date, and another to account for new or modified leases on or after the effective date.

To reduce the amount of time you will spend reevaluating your leases, you can elect a package of transition practical expedients. Among other things, this package of practical expedients allows you not to reassess whether contracts that commenced before the effective date are leases or how those leases are classified. We expect most companies to apply this package of expedients.

You can also make several other policy elections in transition that can simplify the application of the new leases standard. For example, private companies that are lessees are permitted to make an accounting policy election to use a risk-free rate for the initial and subsequent measurement of lease liabilities and right-of-use assets.

While using a risk-free rate might reduce complexity, you should keep in mind that using a risk-free rate would increase the likelihood of a lease being classified as a finance lease and increase the initial measurement of the lease liability and right-of-use asset. In addition, if you’re considering going public, you may not want to make this election because you would have to retrospectively apply the public entity accounting and reporting requirements to all prior periods presented when you become a public company, and this would mean going back and estimating the discount rate.

Lessors and lessees can also simplify their accounting by making an accounting policy election to not separate their lease and associated non-lease components. Lessors must meet certain criteria to apply this election.

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Chapter #4

Determine the effect on IT systems

Because ASC 842 will require companies to gather more information to account for leases, companies may need to consider implementing an IT solution.

Today, many companies use Excel spreadsheets for their lease administration and accounting. Because ASC 842 will require companies to gather more data to account for and disclose information about their leases, companies may need to consider implementing an IT solution. Based on our experience with companies that have adopted the new leases standard, it often took longer than anticipated for their IT solutions to become fully functional.

Companies that decide to implement a new IT system need to design an approach that is right for them. Some of the key decisions include determining:

  • Whether the system should be centralized or decentralized
  • Whether the system should be developed in-house or outsourced to a third party
  • Whether the system can be integrated with the company’s current enterprise resource planning system 
  • Whether the software is scalable to meet the company’s needs over time

These decisions can affect the cost of implementation and how soon you need to get started. Understanding your leasing activities will allow you to make the best decisions for your company.

If you determine that your leasing activities are very simple and can be accounted for using spreadsheets, you should consider the risks of using spreadsheets. They include data input errors, accidental changes, unintentional deletions and the potential that incorrect formulas may be used.

  • 1The FASB has proposed deferring the effective date of the new leases standard for entities other than public business entities; not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed or quoted on an exchange or an over-the-counter market; and employee benefit plans that file or furnish financial statements with or to the SEC to fiscal years beginning after 15 December 2020 (e.g., 1 January 2021 for a calendar-year private company) and interim periods in the following fiscal year. Early adoption, including adoption in an interim period, would still be permitted. Private companies should monitor standard setting in this area.

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Summary

Private companies need to start planning for the new leases standard, even though the FASB has proposed deferring the effective date for private companies, because implementation will likely require more time and resources than expected.

About this article

By

US Americas

Multidisciplinary professional services organization