The challenges created by the new lease accounting standards will not end with transition and adoption of the new rules. In many ways, it’s just the beginning. Your approach to lease accounting and financial reporting — and even the necessary capabilities of your accounting technology — will never be the same again after day one of the new regime.
Compliance with IFRS 16 (AASB 16 in Australia) and ASC 842 standards requires a more systematic approach to the way lease data is collected and extracted in future. You’ll also have to integrate data management and reporting systems, improve processes for sharing data across multiple business functions, and make certain determinations for accounting purposes.
The three elements of the classic “golden triangle” of People, Process and Technology will be at the heart of making a success of compliance in the long run.
What it Takes to Become Compliant – The People Aspect
The new standards make lease accounting much more complex and this will put greater demands on people in many different departments within your organization. This is especially true for lease administrators who will have to rise to the challenge and enhance their level of expertise.
Because Lease Accounting is now taking on a more active role in lease interpretation and data management, Lease Administration is – on the face of it – receiving less attention. This has been readily apparent in organizations during the selection process of a new lease accounting system; Lease Administration is literally taking a back seat in this process. But in reality, every entry or edit now made to a lease record is subject to being “audited”. Translation: every decision Lease Administrators make is likely to have a bigger impact than in the past. And the Lease Accountants, Controller, and Financial Reporting folks are watching!
While Corporate Real Estate will be most affected by the change, many other departments will also be impacted, including these departments and functions:
Transaction team: The dealmakers will have to be more strategic when negotiating the rights, obligations and responsibilities contained in the lease because of their effect on the Financial Statements.
Accounting: The accountants will need to be more closely aligned with the CRE abstraction team as well as being apprised of remeasurements that may be required as a result of lease amendments or changes in circumstances and estimates.
Internal Audit: This department may require expansion beyond what exists today due to the SOX controls surrounding the preparation and effective review of classification, as well as measurement and recording of the Lease Obligation and ROU asset.
Financial Planning and Analysis: This group will now need to forecast for the balance sheet and P&L impact.
Incentive Compensations Plans: This may not seem obvious at first but analysis of an impact on incentive compensation arrangement metrics is prudent.
Financial Reporting group: This group will need to be dialed in with real estate, the lease accountants and the lease accounting system due to the financial statement quantitative as well as qualitative disclosures that the standards require. Global organizations have an additional burden due to local statutory reporting requirements necessitating classification and calculation under both US GAAP and IFRS for those leases.
Tax: The Tax group will be evaluating potential changes and impacts to several functions within their domain including methods, processes and systems.
IT: The technology team will need to consider the applications being supported and the robust reporting that is required, as well as the need for possible consolidation.
Treasury: These analysts and accountants will need to assess the impact on your organization’s financial metrics and ratios and your ability to borrow. They will also have to plan for compliance and reporting of numerous ratios, including debt covenants or other guarantees.
Legal: Your attorneys will need to have an understanding of the compliance standards and the related legal implications and risks. They can provide insight around all contracts and whether they are defined as leases (or contain an embedded lease) as defined per the standards.
Procurement: This group needs to be knowledgeable about compliance in order to understand the impact various types of leasing contracts – such as equipment and vehicles – will create.
When planning for your compliance team, make sure that all departments are represented. The compliance team should comprise a strong and capable cross-functional mix from corporate real estate, financial planning and administration, accounting, tax, operations, procurement, legal, IT, internal audit and (for public companies) investor relations.
What About the Processes?
Changes to the guidance means changes will also have to be made to processes – and this will affect the teams as well as business-as-usual. At the same time, application of the new standards also provides an excellent opportunity to transform the CRE function from merely tactical to strategic.
With people or teams no longer able to operate in silos, decisions made going forward will have larger impacts that will trickle down to the corporate balance sheet. These new processes should therefore be carefully documented to become standard procedures which, of
course, will then be subject to Sarbanes-Oxley controls and scrutiny.
Key items to consider include: negotiating leases, lease versus buy, service contracts with embedded leases, improved space management, renewal options, and policies on expired leases.
Because it may all seem so overwhelming, the key question for many companies will be, “Where do we start?”.
Consider the people who need to be involved in order to bring about and manage change –and form a team. Make sure you have someone on the team who is very familiar with the new standards (at least one person, if not more) – then bring that team together and review current lease and lease accounting policies (if there are any). Ask whether existing lease accounting policies are still relevant? Do they need to be revised or rewritten completely?
What About Technology?
Technology is the third prong that brings all of this together. Without technology, you’ll be staring at a blank sheet of paper, trying to figure out how to do complicated math.
Technology can come in many forms – from spreadsheets, databases (such as Access) and point solutions to fully comprehensive, integrated systems for not only helping you manage leases and comply with new accounting regulations, they can also streamline space, maintenance, projects and sustainability management functions.
There’s no doubt that the new standards will impose greater demands on the capabilities of your accounting technology and it will be more important than ever to have a system that produces reliable data. Experts warn that many existing lease accounting systems may need to be updated or even replaced altogether, because they’ve been made obsolete by the new compulsory rules.
Determining which technology to use in order to ensure compliance is a challenge in its own right. When evaluating the best solution, it is important to take the following into consideration:
Disclosure Requirements – footnote disclosures are already complicated enough, but the additional requirements of the pronouncement mean that all affected departments must be prepared to not only inform and help craft the footnotes but also be able to walk the independent auditors through the support for the footnotes. Multiple locations processing on multiple technology platforms will only make this effort even more grueling – and more difficult to audit.
Can the new system handle all of your leases – Real Estate and Equipment?
Will you have a central data repository for all auditable documents?
If you have international locations, is the new system multi-currency and multi-lingual?
How to Make This Happen
As most companies already have limited resources, it is difficult to ask constrained resources to do something in addition to their “day job”. Finding an experienced partner that can advise and guide you is a good first step. They can review your needs, current situation and constraints. Your selected partner will be able to work alongside your internal cross-functional project team to assist in strategic planning and execution for compliance.
If your organization is seeking a partner to meet your lease compliance and longer-term real estate management needs, we encourage you to contact us for more information or book a demo of our Manhattan IWMS software solution.
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