WLN Articles

Lessee Warning Flare: FASB Lease Accounting Standard Changes Are Coming

It feels like 1998 and 2002 all over again – when the corporate finance community last faced the threat of imminent deadlines, related to Year 2000 implementation and Sarbanes-Oxley compliance, respectively. In 1998 and 2002, we had two years to prepare, plan, budget, and worry. The ambiguity, pressure, impedance, and anxiety that we experienced then have all come roaring back. This time, it’s the deadline for complying with the new IFRS lease accounting standard changes that loom ahead of us.

The question is: will we respond any differently this time? Like many of you, I remember working nights and weekends in both Y2K and SOX situations because we did not start early enough to work on it and there just weren’t enough trained, experienced people to help out, as all of the software engineers and accounting and audit talent were suddenly in high-demand.

Like a warning flare, on July 21st, the International Accounting Standards Board (IASB) and the US-based Financial Accounting Standards Board (FASB) announced their intention to re-expose their revised proposals for a common leasing standard. The announcement states, “Re-exposing the revised proposals will provide interested parties with an opportunity to comment on revisions the boards have undertaken since the publication of an exposure draft on leasing in August 2010. Even through the boards have not completed all of their deliberations, the decisions taken to date were sufficiently different from those published in the exposure draft [in 2010] to warrant re-exposure of the revised proposals. The boards intend to complete their deliberations, including consideration of the comment period, during Q3 2011 with a view to publishing a revised exposure draft shortly afterwards.”

While it is important that any company impacted by these changes use the re-exposure to provide specific feedback, the point here is that the standard for capitalizing all leases will be set and published in Q4 2011. While the implementation deadline will be calendar 2015, your process must be locked down and in place for a full year prior. So, the real deadline is January 1, 2014 for your company to make the transition and have the process, systems, and people in place to manage your equipment and real-estate lease portfolio and generate accurate, compliant reporting. The bottom-line: we have about two years to make it happen.

The reality in all companies is that there are competing demands for limited resources all the time and lots of real and perceived crises along with the expected pressures of the monthly close and quarterly and annual reporting. If most large lessees put down this article and began an aggressive planning, budgeting, implementation project, it would probably take the 2+ years to make it happen.

Here is a resource that can make the process much easier. The Lessee Advocate published a new whitepaper on the coming lease accounting changes for equipment lessees. You can download it for free here The whitepaper explains in detail the potential issues facing equipment lessees under the new lease accounting standards and presents a comprehensive 9-step plan for implementing a transition project and improving the financial performance of your lease portfolio in the process. Lessees can take immediate action with this document. If you are an equipment lessee and have not done anything yet to prepare, this will help you get back on track. If you are already working on it, this will help you sharpen your strategy and tactics. I have abstracted a few of the steps below, as an example.

As a lessee, preparing for the new standard requires that you establish a new database of lease and asset information. Establishing a new database, following the procedures below, will ensure that the information is accurate and up-to-date. It will also ensure that all company stakeholders that need the information for compliance will have it at their fingertips.

Compile a master list of data elements:

Request that stakeholders inside your company help you achieve the following:

• Collect reports that the stakeholders currently use to track the leasing process, e.g., controller’s reports used for financial statements.
•  Compile all data necessary to prepare reports that allow you to examine the impacts of the accounting changes, e.g., data adequate to capitalize operating leases.
• Identify sources of electronic data to avoid having to work with paper documents, where possible.
• Ask lessors and vendors to send .csv or .xls files for all of the electronic data they possess about your lease portfolio, especially asset data including serial numbers and shipping locations; as well as financial information (cost and rent) at the asset level.
• Ask the IT department to send available reports on asset information from the asset management system (if any).
• Ask the procurement and A/P departments to send PO-related information and deal participant data (asset owner, asset user).
• Distill the data elements in these reports into a master table of data elements.
• The lessee-focused lease administration and accounting system you select should support this master table of data elements.

Collect a complete set of internal lease-related documents:

• Collect all original internal lease-related documents, e.g., purchase requests, purchase orders, invoices, certificates of acceptance, master lease agreements, and lease schedules and addenda.
• If you are unsure whether or not you have a complete database—because you suspect that there are some leases that are not accounted for—ask you’re A/P department to send you a list of all leases for which they are making payments, and reconcile them against the documents you have. Contact the lessors and ask them to provide copies of the missing documents.
• Establish procedures for storage of all documents, e.g., a centralized, web-accessible electronic repository using your lease accounting system.

Abstract the required schedule-level data for every lease:

Where the data has not been provided in electronic form, extract the data from the documents to capture the data elements of the master list for each lease, including the following:

Capture the terms of the lease, including:

• Basic minimum term
• Amounts of basic term minimum rents
• Frequency and timing of basic rent payments
• Contingent rents/variable rents based on a rate or other index:
•  - -Formula for calculation of rent based on the rate or index
•  - – Timing of payment of the variable rent
• Contingent rent/variable rent based on usage:
•   – - Formula for calculation of variable rent-based usage
•   – - Timing of payment of variable rent
• Renewal options that are at the sole option of the lessee:
•   – - Term of each renewal option
•   – - Amount of renewal rent payments for each renewal option
•   – - If the renewal option is for fair market value rent, note this fact and any formula for the calculation of fair market value
• Interim rents
• Residual guarantee terms
• Purchase option terms or automatic transfer of title, if any
• Return and maintenance provisions
• Governance information from purchase request, especially the individual who submitted the order. If that person is no longer at the company or in a different position, track down their current replacement
• Determine the internal fiduciary (the asset owner) for each lease schedule.

Integrate data from other sources:

• Reconcile asset data from lessors, vendors, and internal asset management systems
• Then reconcile the asset data with the lease schedule data
• Through integration, pull the necessary data elements from the different systems and consolidate critical data into the leasing systems to provide a centralized view of all pertinent leasing data in one place, thereby enabling best practices for reporting, economic metrics, asset location verification, and end-of-term notifications.
• Reconcile lease payment terms and data with the internal reports used to prepare financial disclosures.

Request that asset owners attest to the accuracy and completeness of the data:

• Send a report of all schedules and assets to each asset owner and ask them to:
•   – - Edit or attest to the accuracy of the data, including: equipment location, end of term (EOT) status, other business coding—general ledger codes, cost center information, project code, etc.
•   – - Determine if they are reasonably certain that they will renew the lease and for how many renewal periods, and if a purchase option exists are they reasonably certain the company will exercise it.
• Using your lease accounting system, capture their attestations of accuracy and lease renewal estimates with a time stamp to begin the audit trail.
• Update your lease accounting system with key financial variables:
• - – Obtain your company’s incremental borrowing rate
• - – Contact the controller’s department to get the spot rate for floating rate leases for variable rents
• - – Ensure these emails and rate support (index publications and spreads if applicable) are captured and auditable for each deal in your lease accounting system

Encourage your colleagues and clients to read the complete whitepaper now and follow the action on the FASB or IASB websites so you are ahead of the curve.

If there is anything that we learned from our Y2K and SOX compliance experiences it is this: a well-informed implementation plan reduces fear, risk, and cost. Changes like this don’t have to be scary. So, get plugged in and make it easy to transition to the new lease accounting standards.