A recent survey found that only one percent of companies had completed adoption of the new lease accounting rules. For the other 99 percent, PwC’s Sheri Wyatt can offer lessons learned from companies that have already made substantial progress with their implementations to help smooth the path forward.
FEI Daily: Did the fact that only one percent of companies had completed adoption of the new lease accounting rules surprise you?
Sheri Wyatt: I would say it was not surprising to me, having worked several companies around the adoption. We're sitting at the beginning of September, and the standard is not effective for calendar year public companies until Jan 1, 2019. So I do think that there's still time.
I would have been more concerned if only one percent had started implementing the standard as opposed to completing implementation of the standard, just given the timing. But, I would say what we've observed is that companies have started a process, whether it's at the beginning of this calendar year, many have been doing it from even 2017 or some even 2016, and I think many companies have started the process, recognizing that the standard is going to be effective relatively soon and the level of effort that it's going to take in order to get to compliance. Again, I'm not surprised that one percent has been completed. I would suspect that many of those are probably the early adopters, the handful of early adopters that we saw.
FEI Daily: Which of the three phases of implementation are most companies in today?
Wyatt: I would say that most companies are probably between the ‘designing the path forward’ and ‘transforming the leasing operation.’ I know many companies have goals, having a system up and running to have at least one quarter of shadow calculations occurring prior to the effective date. So, obviously, we're quickly approaching the beginning of the fourth quarter, which I know many companies were looking to at least have something up in place. I would say we're seeing a lot of companies focused on the Phase One impact assessment and awareness of the lease population in, whether it's first quarter or second quarter, for those that started it this calendar year. But now many companies have identified what their leasing portfolio is and have an understanding of where those lease contracts reside and now are going through the process of gathering the data and designing their system solution.
I will say that that's not all companies. There are probably still the stragglers out there that may just be starting their system selection process or system implementation. We're finding with system implementations that it usually takes longer than you originally anticipate. We've been encouraging companies to the extent that they haven't identified a solution to get that in place. A lot of that is driven by the capacity of these solution providers. There are quite a few out there that are doing it, some specialize in real estate, some equipment, some a combination of both. But if you think about the fact a significant number, 53 percent of public companies and 25 percent of non-public companies, are expecting significant system changes, with a great number of vendors out there, the capacity of those vendors to be able to execute and execute well starts to get limited the longer companies wait.
FEI Daily: In conversations with clients, are they confident that they’ll be ready with a system in time of the effective date or will they take on interim off-line solutions?
Wyatt: I think the answer depends upon how far along the company is in the process. Companies that started their implementation process in this calendar year, 2018, that are in the earlier phases of the system implementation, there may be some concern in terms of whether the system and it's integration with their broader ERP will be ready for the effective date.
Clients come to us and talk to us about the backup plan. ‘We're continuing to move forward with the original plan to have a system in place, but to the extent that that slips, we identify issues through user acceptance testing, et cetera, what can we do to make sure we're compliant 1/1/19 and Q1?’
Interim solutions might be a spreadsheet-based model, which depending upon your portfolio size may or may not be easy to do, or different downsized calculation engines, a database-type solution or what I'll call a calculation engine that's able to provide some interim support.
FEI Daily: How might the timelines vary for different organizations and what are the factors?
Wyatt: In Phase one, which is the ‘understanding what you have,’ the main challenges that we've seen companies have has been around the population identification. Today, many companies use a spreadsheet in order to classify their leases, so then they feed straight line information into their system. And we have disclosure requirements under current GAAP, so I think many companies are starting from there, saying ‘Let me make sure I'm comfortable with what I've been reporting from a disclosure perspective.’
But what's been found on several occasions is that, as you start to have conversations, particularly for decentralized organizations, multi-national organizations, there may be more apps out there that may not, for whatever immateriality decisions that were made out in the field or otherwise, have been incorporated in some of those schedules. And, even beyond that, is this concept of whether an arrangement that's not papered as a lease contains what we call an embedded lease. That often requires engagement of people outside of the finance function, more operational people who understand what contracts they might be entering into as part of their supply chain, as an example, and getting an understanding of whether there's a risk that there could be these embedded leases in those arrangements.
That's probably taken more time than companies originally expected. I do think that everyone was going in with the awareness that there was going to be this level of effort. What I've found in some of my discussion with clients has been that the embedded lease and the fact that you're trying to get information from potentially non-accountants and trying to convey the concept to be able to get that information to make the assessment has been time consuming and challenging.
FEI Daily: What about the data element of this?
Wyatt: That's where companies went in eyes wide open in terms of where they may have some limitations on the data. I think about what today's standard requires. You didn't necessarily need to have a repository with all the terms needed for lease classification and measurement because most leases were operated leases. And so I think the companies have spent a significant amount of time around, ‘Okay, I've identified the contract. Now how do I get the elements of that contract into my new lease accounting solution?’ So that has been something when we think about resource needs, it's a question of whether I'm able to identify someone internally that can do the extraction or other tools that can be leveraged.
Data has been what I'll call the long pole on the tent, because I think the more leases you have and the less reliance that you have on a solution or a contract repository or data management type solution, the more effort that it was going to take in order to get the terms needed to go into the solution. When we think about the lease accounting solution, the expectation is that the company is going through the effort to identify what terms are going to be needed to be recorded into the solution. So that puts a lot of pressure on companies to get through that process quickly in lock step with the implementation of the solution.
FEI Daily: Can you possibly put the level/significance of the effort in relative terms to other new accounting standards?
Wyatt: I think the challenges with implementing revenue recognition and leasing are different. Revenue was a very technical, accounting-based standard. Yes, there were process and system changes that needed to occur, but a lot of the work that companies are focusing on, from an accounting perspective, is around understanding what the impact is going to be and to translate that into process and potentially system changes.
For leasing, it's been less around the technical accounting and much more around the operational and systems element of it. I’m not underestimating the fact that there are some accounting considerations that are challenging. But compared to revenue recognition, much less of the complexity.
While the combined spending on implementing revenue and leasing may be comparable for many companies--- particularly companies with large leasing portfolios -- the split between how dollars are spent is very different. With revenue recognition spending is focused on technical accounting conclusions, white papers to document process and controls. Whereas leasing, a lot of the effort has been around data and systems, and that's where you're leveraging people beyond your core technical accounting folks that are usually responsible for implementation of these new accounting standards. So, it's become a broad effort across the organization.