The New Leasing Standard is Coming -- Are You Prepared for Adoption?

Adoption of the new leasing standard is less than six months away for calendar-year-end public companies, and it’s time for continued focus in the area. Based on PwC’s latest survey results, most companies are still assessing the impact and are realizing adoption may be more difficult than originally anticipated. I provide practical considerations for companies, audit committees and auditors as they prepare for adoption.  

Assess the impact on risk assessment

Its application may result in changes to the financial processes and controls for companies with important lease activity. Management and auditors will need to perform a risk assessment, considering impacted significant accounts and disclosures, to identify areas where there may be risks of material misstatement. As with other new accounting standards, a thorough and timely risk assessment will allow management to determine what incremental risks require modification to existing controls or the development of new controls, including those over the development and maintenance of new leasing systems.  

Management should have an implementation plan

As with the adoption of any new standard, management should have an implementation plan that considers its impact, timing, cross-functional resources (not just Finance) and project governance. A recent PwC Survey revealed that over half of public company respondents find project management somewhat to very difficult, so it is important that the right people are involved in project oversight to ensure progress is continuously monitored.  If you don’t already have a detailed plan, attention is likely needed in this area.

Designing and implementing new internal processes and controls

The adoption will likely require companies to develop a process and related controls over the implementation, as well as ongoing controls. This includes controls over data and assumptions. Companies may need to capture additional data elements, which may require new data sources.  

One particular process to consider is the identification of lease contracts. Management should consider how it will document both the adoption and ongoing controls over assessing the completeness of contracts. The lease identification model under ASC 842 differs from the previous model. In light of transition, many companies are taking steps to satisfy themselves that leases embedded in other arrangements are captured. The requirement to assess embedded leases is not new, but balance sheet recognition from the date of adoption makes the judgment as to whether a contract is or contains a lease much more important.

There may be areas where companies look to address embedded leases through accounting conventions. Companies may also design their processes to only assess contracts that have a reasonable possibility of containing a lease rather than perform an assessment on every type of contract, as there is less risk in certain populations of contracts. When companies decide not to assess certain contracts to determine if they contain a lease, both the company and auditor will need to consider the risk that those contracts contain leases -- including embedded leases -- that could materially impact the financial statements.

Consider the implications of IT

The PwC survey mentioned earlier revealed that more than half of public company respondents expect to make system changes to implement the new lease accounting standards, and of those, nearly one-third were unsure or did not think they would go live with their system changes for the effective date.

These findings further highlight how critical it is for companies and auditors to consider NOW how accounting and IT personnel are communicating and coordinating changes to existing systems, implementation of new systems and how those systems are tested for operating effectiveness.   

Accounting conventions

The standard allows for certain accounting policy elections, such as where a lessee elects not to apply the balance sheet recognition requirements to short term leases -- 12 months or less -- or where a lessee or lessor does not bifurcate contractual payments between lease and non-lease components before applying the balance sheet recognition provisions to the lease component.

Other accounting policies a company may elect that are not contemplated in the standard may be an accounting convention that needs to be assessed to determine it’s materially consistent with GAAP. These policies may need to be assessed both upon adoption as well as on an ongoing basis to confirm the original assessment. Examples include consideration of whether leases of a certain magnitude and/or duration do not need to be assessed (similar to conventions companies currently have for fixed asset capitalization), recording and accounting for portfolios of similar assets as a singular assets or developing one borrowing rate for certain portfolios of similar leases or lease classes or leases in a given territory.

Early auditor involvement

Lastly, companies should be thinking about developing and documenting processes and controls over the disclosure requirements in the year of adoption and beyond. Early coordination and establishment of expectations is important; there are both qualitative and quantitative disclosure requirements required, and management and auditors are also required to assess controls related to SAB 74 disclosures in the period prior to adoption.

For companies, audit committees and auditors, time is now of the essence to prepare for adoption. Unlike the experience of many companies that adopted the new ASC 606 standard for revenue, it is likely the adoption and disclosure impact for leases will be significant, and. considering the potential impact on relevant stakeholders, including management, the audit committee, auditors, investors, and debt holders, amongst others, will help ensure a successful adoption.