What is Day 2 of the New Lease Accounting Standards?
If you are working on the lease accounting standards implementation project, chances are you know what your “Day 1” is – the effective date of the new standard for your company. For calendar year-end filers, Day 1 will be January 1st, 2019. “Day 2 and beyond” refers to the days post-adoption, when companies will be required to follow the new standards and maintain compliance.
So far, the focus of most businesses has been on achieving compliance by Day 1. This includes gathering all of the necessary lease data and uploading it into a system of record so that each lease can be reported as a right-of-use asset and liability on the balance sheet. However, at this stage in the process, with the deadline only a couple of months away for many organizations, it’s critical to consider how your company can maintain compliance past the deadline.
Maintaining compliance may not be straightforward for many companies. It will involve establishing processes, policies, and controls to ensure that every lease is reported accurately, updated timely, and removed when it reaches end-of-term. Companies with large lease obligations will find that it is nearly impossible to maintain these processes without specialized lease accounting software. However, despite some upfront investments, improved management of the lease portfolio can also create opportunities for cost savings.
1. Capture New Leases
Do you have a process in place to capture every new lease that is signed? If you don’t, the accounting organization will always have to catch up with the actual lease portfolio, much like they had to do during the lease identification phase of the implementation project.
Consider working with Procurement to create a process to capture new leases as they come in. Procurement will touch each new lease, as well as service agreements that may contain embedded leases. If Procurement is trained to identify contracts that might be a lease, they can pass those contracts onto Accounting for further analysis and upload into the system.
Treasury may also play a role by establishing a lease versus buy process to serve as a control on the leasing program. The lease versus buy process can ensure that each asset request is analyzed to ensure the selected procurement method is the best use of capital. If the lease request is approved, then it can be documented in the leasing system of record.
2. Track Changes to Leases
There are situations that can occur throughout the lifecycle of a lease that can result in changes to the accounting, like reassessments, remeasurements, and modifications. It’s important to track any changes to critical data that could impact the accounting. For example, if the lease term increases or decreases, that could require a remeasurement of the lease asset and liability.
Consider periodically requesting attestations from asset owners on the current state and plans of each asset on lease. This will allow you to determine if any critical data, like end-of-term plans, has changed.
3. Manage the End-of-Term
At many organizations, it’s common to see asset users inconsistently reporting their end-of-term decisions, like renewing or terminating a lease, to back-office groups. This could lead to a couple of issues:
- If Accounts Payable is not informed that the lease term has ended, they could continue making payments on it. This situation is called being in “evergreen.”
- Another possibility is that Accounting could continue to include the lease in the balance sheet valuation. When Accounting later realizes that the lease no longer exists, they would have to complete a prior period adjustment.
To better track an asset’s existence, consider setting up an incentive program to encourage asset users to report their end-of-term asset decision. For example, if an asset user helps eliminate an evergreen payment, that expense can go back into their budget.
Many companies will elect to purchase a more sophisticated lease accounting application. While these systems will require a higher upfront investment, they may offer a lower long-term cost by reducing the number of new employees required to support the lease accounting program. Along with push-button reporting for the new standard, a complete lease accounting software solution can automate many necessary processes, reducing the risk of manual error. A complete solution will allow for:
- Customizable Policies – You should be able to set a policies, like requiring that high-value asset requests go through a lease versus buy analysis. This will allow you to create a record of all high-value assets on lease. Automation also allows for an audit trail, file backup, and versioning.
- Notifications – You should be able to automate asset tracking processes. For example, the lease accounting system could periodically send email notifications to asset users requesting that they attest to the existence of assets as well as the completeness and accuracy of the lease population.
- Integration – You should be able to integrate the lease accounting application with the IT, Fleet, and Real Estate asset management systems. Integration will allow both the lease accounting software and the asset management software to remain up-to-date with each other as changes occur.
A well-maintained lease portfolio can generate savings. For example, notifying asset users of approaching critical dates, such as a renewal option exercise date, will allow them to make the optimal economic decision for the asset in a timely manner. Requiring asset users to report their final decision on whether to exit or renew a lease will also ensure that Accounts Payable does not continue to pay for equipment or a property that is no longer on lease. In addition, improved tracking of asset data will allow you to analyze your lease terms to determine how competitive they are – knowledge that will help in future lease sourcing negotiations.