Transforming The Balance Sheet: Navigating New Lease Standards For Success
Author: Panos Kakoullis
2019 heralded the start of a financial reporting revolution, as new leasing standards came into effect-transforming company balance sheets across industries. The new guidelines require businesses to include details of all lease arrangements from company cars to office space and equipment. Although the aim of the International Accounting Standards Board’s (IASB) IFRS 16 and the US Financial Accounting Standards Board’s (FASB) ASC 842 is to create more transparency, leaders are grappling with the complexity of implementing these new requirements. In the US alone, the FASB’s new accounting standard is estimated to bring $2 trillion of lease liability into S&P 500 balance sheets.
Adopting the new standards will have a major effect on the preparation of financial statements and bring new light on business operations. Yet Deloitte’s Global IFRS 16 and ASC 842 readiness survey in 2018 revealed that, at the time, most organizations were not adequately prepared, and largely underestimated the impact of the new standards. Furthermore, the new regulations present varying challenges for businesses including the collation of data, the need to upgrade or source lease accounting technology, and preparation for the impact of material changes to financial reporting and communication.
With both standards in effect, there are three key strategies CFOs and finance leaders must employ to ensure both compliance and a smooth transition:
Streamlining Collation of Lease Data
Today, efficient data management remains a top priority across all areas of business. A Deloitte survey revealed that two of the greatest challenges during the transition to the new standards are: 1) collecting lease data, and 2) gathering a complete population of lease contracts—55% and 54% of respondents across 21 countries indicated these as primary concerns, respectively.
To address looming data challenges, diligent project management is required to initiate multi-disciplinary collaboration—accounting and finance must closely collaborate with information technology, real estate, tax and procurement departments to share the necessary data. Companies must implement new business processes, policies, controls and internal communications to ensure full compliance and appropriate disclosures for all existing and future leases. Since the release of the survey, experience shows that ensuring the quality of the data up to the level required for financial reporting purposes is not always an easy task.
Implementing Dedicated Software Systems
In the era of Industry 4.0, businesses rely on software systems to evaluate a wealth of data at their fingertips. As implementation was progressing, many companies realized that a dedicated software solution to handle lease management and lease accounting is just essential to process the substantial volume of data required by the new standards. In the survey, forty-five percent of companies reported holding more than 1,000 lease contracts, and 19 percent held more than 5,000.
Investing in accounting software will inform decision-making and minimize the time required to extract analysis. CFOs and accounting leaders in multinational organizations must also have global insight into how the combined new US and international standards will change reporting requirements across multiple jurisdictions. Utilizing technology to create a centralized process for recording and analyzing all leases throughout the organization will also safeguard quality, compliance, streamline adoption and mitigate audit risks.
Navigating Material Changes to Financial Reporting
As organizations finalize implementing the new standards, companies should anticipate a significant impact on balance sheets for lessees. For example, the new standards have the potential to affect the calculation of Key Performance Indicators (KPIs), debt covenants and even management compensation. Yet, in 2018, companies appeared unprepared—while approximately 52 percent of our survey respondents anticipated a material change to their financial reporting, they were uncertain what to expect. And, almost 80 percent indicated no plan to change their KPIs as a result of implementing the new standards.
To address this challenge, businesses should develop a robust communications plan to responsibly communicate changes in their KPIs and income statements, preparing investors and creditors to understand the impact.
Forging a new way forward
Overall, the new leasing standards will have far-reaching implications on tax, accounting and reporting, directly impacting the negotiation and renewal of future lease contracts. Going forward, accuracy and efficiency depends on creating greater collaboration between business units, finance and lease accountants to successfully assess the impact of leasing decisions on balance sheets, factor in new accounting realities and carefully structure future agreements.
Businesses have considerable work to do to ensure full compliance and require a comprehensive roadmap to successfully navigate this complex transition with confidence. Is your business prepared to address this change?