With new lease accounting standards (ASC 842) set to take effect at the end of the year, corporate accounting teams are focused on getting ready. This isn’t an easy transition for many companies, according to Robert Kugel, senior vice president and research director at Ventana Research, a business and technology research firm. In the interview below, we spoke with Kugel to understand the impact of the new lease standards, the challenges they create, and how finance should be thinking differently about compliance with these and future changes.
How are the new lease accounting standards impacting finance organizations?
Most accounting departments are working overtime these days grappling with two significant changes in accounting standards at once. In addition to recent changes in lease accounting rules, there are new standards for revenue recognition for contracts. The new standards for leases (ASC 842 for U.S. companies and IFRS 16 elsewhere) require a significantly higher level of data collection, analysis, controls, and review than had been the case until now.
Companies must adopt completely new accounting frameworks for contracts and leases and, for most, the accounting is more detailed and complicated than before. Most departments are experiencing heavier workloads implementing and complying with the new standards. And unfortunately, they’re being overwhelmed at a time when they should be stepping back and taking a comprehensive look at how best to handle lease accounting. They especially should consider how to balance the needs of all stakeholders involved with equipment, IT and real estate leases while reducing administrative workloads and ensuring compliance.
The new standards are a significant departure from how accounting for revenue and leases have been handled in the past. Is there a bigger trend at work here?
From my perspective, the new standards aren’t an aberration; they’re the new normal. Underlying the new standards is the aim of providing investors, analysts, and other users of financial statements with more complete and objective disclosures. These disclosures require richer well-controlled data sets and more insightful analysis than was the case in the past. The new standards also are intended to be principles-based, which for U.S. companies is a switch from the more rules-based approach that was the norm. Principles-based accounting, which is more in line with how the rest of the world applies standards, gives businesses greater flexibility in applying a standard than a rules-based approach. At the same time, principles-based accounting requires enhanced process and calculation controls to ensure consistency of accounting treatments.
The introduction of these new standards assumes that companies have IT systems and IT-supported processes in place for efficient compliance, such as the ability to gather a broader set of data from multiple departments and support the required analysis. However, many finance teams are still working in spreadsheets, which cannot support the complex processes and controls needed for compliance.
To your point, many finance teams continue to rely on spreadsheets for lease accounting. Why will this be an issue when it comes to complying with the new lease accounting standards?
First, let’s acknowledge that spreadsheets are indispensable for finance. They are the ideal choice for personal productivity as well as ad-hoc analyses and reporting. However, they’re the wrong choice for any repetitive, collaborative enterprise task like lease accounting. Our spreadsheet research shows that they’re error-prone: 35 percent of organizations said they routinely find errors in data and 26 percent find formula errors in the most important spreadsheet they use. Because of errors and process issues, spreadsheets are the hidden productivity killer in finance departments. Our research finds that, on average, people in finance spend 18.1 hours per month maintaining the most important spreadsheet they use.
“In the absence of a single source of the truth, departments will have to spend time on checks, reconciliations, and correcting mistakes.”
Accounting for leases is complicated because most larger companies and even some midsize ones typically have hundreds and even thousands of property and equipment leases in force at any time. Lease data needs to be analyzed to create journal entries. These entries will need to be reviewed and approved, which makes controlled workflows a necessity. Companies must be able to reliably capture a wide range of financial and non-financial data related to the lease and make it available in a single authoritative system rather than scattered across the company on multiple servers or individual hard drives. In the absence of a single source of the truth, departments will have to spend time on checks, reconciliations, and correcting mistakes. Spreadsheets circulated as email attachments aren’t the right choice. They unnecessarily multiply administrative burdens of lease accounting.
The new lease accounting standards require periodic remeasurement of the lease. How does that affect finance departments and the systems they use?
Good point—lease accounting is no longer static; all leases must be reviewed periodically and their value remeasured when necessary, such as when a lease has been modified. Even without a signed change to a lease, remeasurement may be necessary. For example, if options to renew aren’t likely to be exercised because a store is losing money, the lease obligation will be reduced on the balance sheet. This is a cross-functional process, where owners of the lease arrangement—the real estate department and operating managers—must methodically examine their leases and report any material changes that can affect their valuation to the finance department.
Managing lease reviews and remeasurement often requires the use of complex models and formulas to assess the value of lease obligations, which is more difficult and time consuming to do in a spreadsheet. This is reflected in our Finance Analytics benchmark research, with two-thirds (67 percent) of participants reporting that spreadsheets make analytical tasks difficult. Spreadsheets also cannot provide the controls and auditability necessary for documenting compliance.
“Using spreadsheets for lease accounting will be an ongoing productivity drain because of their inherent limitations.”
Finance departments need a system that ensures that calculations are performed accurately and consistently with baked-in high-level controls and documented compliance.
As finance organizations assess whether they have the right systems in place to comply with the new standards, what is most important for them to consider?
Companies need a financial management system designed to manage the end-to-end process of recording, storing, accessing, analyzing, and reporting all relevant lease-related data, covering the entire accounting lifecycle from the inception of the lease. They need to comply with the lease accounting standards without cobbling together spreadsheets to fill in gaps in their existing systems. In almost all cases, processes for equipment and real estate leases and accounting for them are scattered across the enterprise. Corporations need a system that connects finance departments to operating business units and real estate departments.
It’s also important for executives to recognize the need for processes and systems that serve without compromising the business needs of all parties involved with leases. For instance, real estate departments have operational and automation requirements related to how they set up, manage, and renew leases and manage leasehold improvements. The real estate department may have a lease management system, but it’s designed to handle real estate management tasks and may not adequately address the needs of the finance organization. In industries where there are sophisticated requirements, having a dedicated lease management system operating in parallel and set up to share data may be a more efficient approach than downloading lease management data into spreadsheets to handle lease accounting.
Why is now the time for finance organizations to evaluate their current financial systems and consider whether they’re adequate to support the dynamic nature of business today and in the future?
Departments that are relying on spreadsheets for their initial compliance requirements shouldn’t assume that once they’re over this hump their workloads will become manageable. Using spreadsheets for lease accounting will be an ongoing productivity drain because of their inherent limitations. They were never designed to perform repetitive collaborative enterprise tasks.
In addition, finance organizations should look beyond compliance with the new revenue and lease accounting standards and evaluate whether their financial management systems can handle similar accounting standards as they are introduced as well as the inevitable tweaks to–and changes in interpretations of–the new standards over the next several years.
Large and midsize enterprises are adopting cloud-based financial management systems to support increasing regulatory change. Rather than requiring a company to perform its own modifications or reimplementation of software, the software vendor makes the changes, which are then available to their customers.
Interested in learning more about what the new lease standards mean for your organization, how companies are preparing, and what’s needed to maintain compliance? Register for the upcoming webinar “New Lease Accounting Standards: Spreadsheets are No Longer a Practical Option” with Robert Kugel and leaders from the University of Rochester and Workday.