Implementation of the new lease standard is not only changing accounting practice, but it is forcing senior level financial executives to rethink their approach to leasing as a business practice.
Scott Muir, partner in KPMG's Professional Practice Group, will be speaking at Financial Executives International’s 2017 Accounting Change for Financial Leaders Conference on June 27 and 28. Dianora DeMarco, Manager of Accounting Policy at FEI spoke with Scott about what some of the issues attendees should be thinking about prior to the conference.
The video and an edited transcript are below.
Dianora DeMarco: Financial Executives International’s Committee on Corporate Reporting (CCR) has organized a leases working group, and we've been highly involved with companies throughout the implementation process. We're hearing that companies are in different stages of implementing the leases standard.
From your perspective, where would you say most companies are?
Scott Muir: I think it's hard to generalize the population as a whole. There's certainly some companies that have moved at a quicker pace and, of course, many others that are further behind. I think, from the perspective of being behind, a lot of companies are still busy trying to digest the revenue recognition standard.
And to the extent they are still mired in that implementation, it's hard to move on to another large-scale implementation. I think to some extent the degree to which a company has moved forward at pace for the leases standard depends on how significant an effect they had with the revenue recognition standard.
DeMarco: Would you say there are certain companies that are farther along? Does it vary by industry or the size of the company?
Muir: I think the size of the company matters because the larger the infrastructure you have, the more capable you are of handling two large-scale implementations at the same time. Certainly, we've seen of the companies that are further ahead in terms of leases implementation, they are likely to be larger companies versus smaller entities.
From an industry perspective, I think there's a direct correlation between how fast you are moving on leases in both how significantly affected you are by the leases standard and how much you have been affected by the revenue recognition standard.
By way of a couple examples, industries that we have been involved with quite heavily in leases implementation already are the retail and the transportation industries. What both of those industries have in common is that they are going to be significantly affected by the leases standard, while the revenue recognition standard has had a lesser effect on them than many other industries.
DeMarco: How much of this is actually a finance-driven exercise? How important are cross-functional teams in implementing the leases standard?
Muir: As with any accounting change exercise, finance is going to have a pivotal, if not key, role to play. However, when it comes to leases in particular, because leasing is often such a business-decentralized-type activity, I don't think finance would ever be in a position to implement this standard or to apply it on a go-forward basis on their own.
I think you would always need involvement from the legal group that's involved in drafting the contracts that get executed. You’ve got various business units that are going to be entering into leases in decentralized locations. You might have a real estate group that you have enter into a lot of leases.
In all those cases, it's going to be vital to have timely interaction with these groups to make sure the accounting folks know when new leases are entered into, when leases are modified, and when other events that are called for in the standard occur that might trigger things like a remeasurement or an impairment.
Further, as you think to transition to the other groups that we are constantly telling people they want to involve early and often, such as the audit committee of the board of directors, so that they are aware of the actions the company is taking to comply with these accounting changes, and the investor relations group.
If you take some of these industries I just named, where it's going to add billions of dollars to a company balance sheet, that's something that you want to ensure your investors, analysts and other users have a handle on before they suddenly appear.
DeMarco: While we’ve been getting “snippets” of where companies are in adopting the standard during implementation, when can we expect more robust disclosure?
Muir: The expectation that was set out by the SEC in a meeting last fall is that you will incrementally add to those disclosures through the implementation process. Obviously, nobody expects that you're going to have all the answers either about what policies you're going to elect, or about the quantitative or qualitative effects of the standard the day after it's issued.
But we're 15 months since the issuance of that standard, and we have another year-and-a-half or so until the effective date. You assume that companies will start to make decisions that they can disclose about, "Are we going to early adopt or not? Are we going to adopt the package of practical expedients or the hindsight practical expedient in transition?" What sort of accounting policies do we think we're going to adopt going forward?"
Another issue that we highlighted in a recent publication KPMG put out on these transition disclosures is that we would generally expect lessees to be able to provide some sort of at least quantitative range in the near term about what's going to happen to their right-of-use assets and lease liabilities on their balance sheet, because this information is already captured for their footnote disclosures.
DeMarco: You mentioned the practical expedients in the standard. Can you talk a little bit about those practical expedients, and how they can ease the burden for adopters?
Muir: I think the practical expedients and how much they ease the transition burden will vary by company.
The expedients that are available include the ability to use hindsight with respect to certain judgments and estimates that a company may have. Just like today — tomorrow, when you're under Topic 842
, you're going to make estimates about the lease term. It may or may not include renewal options in certain situations. In certain cases, you may not know when you get to the effective date of the standard. So, the use of hindsight expedient permits you to, rather than looking back and trying to figure out what you may have thought in the past had you been recognizing these assets and liabilities, allows you to use the information you now have.
The second expedient that's available in transition is a package of practical expedients that have to be elected all or nothing. And now what these permit an entity to do is decide that they are not going to go back and reassess whether a contract that they decided is a lease under Topic 840
, or current GAAP, is going to be a lease under Topic 842
, or the new standard. It also involves not having to choose to go back and reassess lease classification or revise your accounting for initial direct cost, which is substantially different under the new standard versus the old.
DeMarco: So it sounds like there are some new key areas of judgment, perhaps, in the new standard? What are some of these new key areas?
Muir: I think things that were judgmental before now carry more judgment as we move forward.
Just by way of example, again, the lease term is a judgment you made today, it's a judgment you'll make tomorrow, but now it's going to directly affect your assets and liabilities on your balance sheet.
That's going to be a key judgment for how you do your accounting for your leases. There's going to be other key judgments, depending on whether you elect, for example, the bright line lease classification thresholds that are available. If you don't elect these bright line classification thresholds, you will have judgments to make about, for example, whether a lease is an operating lease or a finance lease if you're a lessee.
DeMarco: So let's say that I'm a company that's adopting January of 2019, and between the leases standard, the revenue recognition standard, and the 20 other ASUs that the FASB issued last year, I'm feeling like I might be behind.
What kind of things can I do to get up to speed?
Muir: Well, I think it's important to recognize a couple of things when you think about where you are today. First off, if you are one year from today in fundamentally the same spot that you are in right now, you're probably going to feel that you are definitely behind. You're going to feel in trouble, and you're going to feel in a rush to make the 1/1/19 deadline.
I would encourage companies to use this year wisely and not assume you can wait until you've gone live with the revenue recognition standard to even pick up the book and start getting to work on the leases standard. One of the things that you know, probably the first and most important step, and the foundation upon which a successful implementation will rest, is identifying your full and complete lease inventory, your population of leases and understanding how complex those leases are.
DeMarco: How easy is that to do, though?
Muir: It can be very difficult. To some extent, it depends how complete and how comfortable you are with your current lease population today. The other thing that is important to think about is the cross-functional aspect that we have discussed.
There are often times where leasing has been decentralized. There is an exercise that, regardless of how comfortable you are, you should undertake to determine whether you have captured not just all of your contracts that are labeled lease agreements, but those embedded leases that may not have been so vital to identify under current GAAP.