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In 2016, the Financial Accounting Standards Board (FASB)released a new set of lease-accounting standards that requirecompanies to change how they report on their operating leases.Instead of mentioning leases only in the footnotes of theirfilings, they will now need to report a right-of-use asset and alease liability on the balance sheet for each operating lease. Thischange was a result of a U.S. Securities and Exchange Commission(SEC) initiative to close accounting loopholes and increasetransparency into the financial position of companies.

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The new lease-accounting standards are known as ASC 842, andpublic companies are required to apply them for annual reportingperiods after December 15, 2018. For public companies with afiscal-year start on the first of the year, that means theirdeadline will be January 1, 2019. Private companies will berequired to apply the standards for annual periods after December15, 2019—one year later.

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The SEC also now requires companies to file Staff AccountingBulletin (SAB) 74 disclosures describing the expected impact of anynew accounting standard. With regard to ASC 842, the SAB 74disclosures provide insight into companies' preparedness forimplementing the new lease-accounting standards. We recentlyreviewed quarterly and annual SAB 74 disclosures issued over thepast year by 100 companies with high operating-lease obligations,with the goal of gauging their progress and better understandingkeys to success in implementing the ASC 842 standard.

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Impact on Corporate Financial Statements

The first thing we found is that many of these companies stillhave a way to go to full implementation of the ASC 842 standard.Few provided much information in their SAB 74 disclosures, which isnot surprising since we still have several months till thestandard's effective date. However, a handful of companies offeredgood examples of what needs to be disclosed, as well as insightsinto how they are approaching the project.

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Of the 100 companies whose disclosures we evaluated, more thanthree-quarters have determined that the new lease-accountingstandard will have a material impact on their balance sheets, butfew have provided a quantitative estimate of it. Among those thathave quantified the impact, estimates range from $1.2 billion to$13 billion per company.

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At the time of their SAB 74 disclosures, most companies werestill evaluating the impacts that ASC 842 will have on their incomeand cash flow statements—but among those that had finished theprocess, the vast majority said there would be no impact toeither.

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Eventually, all companies will need to determine and report theexact material impact that ASC 842 will have on their balancesheet. Doing so will involve a long data-collection process withfew shortcuts. Given that most companies are used to reportingtheir leases off-balance-sheet, many have never needed to trackleasing data closely. Pulling operating leases onto the balancesheet will require companies to keep much more detailed data inorder to ensure that the right-of-use assets and lease liabilitiesare calculated correctly. For example, any data fields concerningpayments; expenses; or end-of-term options like renewal, buyout, orreturn could impact the lease's valuation.

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To streamline the data-collection process and arrive at thebalance sheet impact of ASC 842 as efficiently as possible,companies should analyze the new standards and their softwarerequirements to figure out what new data they will need to collectand have on hand. After making these lists, many companies willrealize that some of the necessary data is not on their leaseagreements, so they will have to go to the asset users or even thelessors to complete their datasets. By knowing ahead of timeexactly what data they will need, companies can avoid having tofrantically track down information at the last minute.

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Implementation Status

In our research, we found that only 13 percent of companies haveformed a project team. This is one of the most crucial aspects ofimplementing the lease-accounting standards because rollout of theleasing standards, unlike many accounting projects, is anenterprisewide undertaking. Successful implementation will requirea cross-functional team made up of representatives from all thebusiness units that touch leasing, including procurement, accountspayable (A/P), treasury, corporate IT, and users of the leasedassets.

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These representatives will not only help track down the leaseagreements, but also provide insights into designing the futureleasing program; developing processes that will enable the companyto efficiently collect and report the necessary information;choosing among practical expedients that the FASB has offered tohelp some companies streamline implementation; and selectingleasing software. For example, an A/P representative can help theproject team track down leases by providing a list of all paymentsmade monthly, quarterly, or yearly. However, A/P will also beconcerned with establishing processes to ensure that all leasepayments are made on time but are not continued past the end of thelease's term.

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Corporate treasury will play a significant role in the ASC 842implementation project as well, as treasury owns the balance sheet.Now that many major companies are expecting a significant increasein assets and liabilities on the balance sheet, many treasuryorganizations will be focused on optimizing the use of capital inthe leasing program. As a result, treasury will be heavily involvedin establishing updated controls around processes like thelease-vs.-buy analysis and sourcing of leased assets. Treasury alsoowns the relationship with many of the potential lessors (vendorsand landlords) that the company may lease from in the future,adding an important perspective to designing controls.

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The project will also require an executive sponsor to secure thenecessary budget and advocate for the importance of the project.Some business functions may not understand why the project is socrucial, or why they should dedicate resources from their group tohelp complete the project. The executive sponsor will beresponsible for getting the proper approvals to make the project asuccess. The chief accounting officer would be a good choice forthis role.

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Practical expedients. One of the crucialdecisions the project team will need to make is which practicalexpedients to select. For example, one practical expedient has beendubbed the “package of three.” It grants lessees the option toavoid the reassessment of whether existing contracts contain alease, the classification of those leases, and the initial directcosts of those leases. Another practical expedient lets lesseesdecide whether to separate lease components and non-leasecomponents. (A non-lease component is a good or service that is notdirectly related to paying for the right to use the asset on lease,like the operating costs of a building.) The FASB also recentlygranted an option for lessees to not apply the transition provisionto the comparative period, which would mean they would not need torestate their financial statements from the prior two years.

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The choice of practical expedients could ultimately impact thesize of the increase to the balance sheet, software requirements,and policy updates, as well as the time required to implement thestandard. However, only 11 percent of the organizations in ourstudy commented in their SAB 74 disclosures that they have selectedor are evaluating the practical expedients the FASB hasoffered.

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The practical expedients are designed to ease implementation,but companies cannot assume that every practical expedient will beright for them. The project team will need to weigh the pros andcons of each option as it relates to their industry and company.What might make sense for one company could result in an unwantedimpact for another.

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Software selection. Due to the scale ofthe leasing project, most major companies will need to select alease-accounting software application to automate their leasingprocesses. However, according to the disclosures we reviewed, only18 percent of companies claim to have evaluated, selected, orimplemented a software solution.

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A lease-accounting system helps companies generate the reportsand disclosures required by the new lease-accounting standards.Unlike spreadsheets, a complete lease-accounting solution canautomate many of the processes involved with calculating theright-of-use assets and lease liabilities, reducing the risk andcost of manual entry and calculation. Lease-accounting systems arealso capable of accounting for both equipment and real estateleases, so they cannot be easily replaced by real estateadministration software.

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The basic features that all lease-accounting solutions shouldhave are: first, a lease-accounting subledger that can collect allthe necessary data at the asset level as required by the newstandards; second, a lease-accounting engine that can generatedebits and credits at the asset level and aggregate them to theschedule level; third, automatic lease classification; fourth,financial disclosures and reporting for ASC 842, as well as IFRS 16if the company reports internationally; and finally, responsibilityand management accounting.

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The first step the project team should take in the softwareselection process is determining a list of requirements theirsystem has to have, as well as features that would be nice to have.This effort needs to heavily involve IT staff, who can developsecurity and integration requirements, as well as the accountingteam, who can develop technical accounting requirements.

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Policies and controls. To achievecompliance with the new lease-accounting standards by theimplementation date and to maintain compliance in the future,companies will have to update their leasing policies and controls.According to the SAB 74 disclosures we looked at, 18 percent ofcompanies have begun evaluating or are implementing new policiesand controls.

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While the current focus of most companies is, understandably, oncollecting and uploading lease data, it's also crucial fororganizations to begin establishing updated policies that willallow them to maintain the same level of data in the future, whilealso withstanding the increased auditor scrutiny of the newstandard. For example, companies can incentivize asset users toregularly update the lease database with any changes to an asset.Organizations can establish key performance indicators (KPIs) thatmeasure critical success factors of the leasing program and canassign the KPIs to stakeholders to track progress.

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The treasury team can play a role in establishing policies andcontrols designed to help optimize the company's use of itscapital. For example, they may want to require that asset requestsabove a certain dollar value go through treasury for approval.Moreover, treasury can take control of the lease-vs.-buy decisionprocess for these high-dollar asset requests, in order to ensurethat the company is choosing the best option in terms of cash flowand long-term business needs. Treasury managers can also use theirrelationships with potential lessors to ensure that leases aresourced competitively.

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Inserting treasury expertise into decisions around thesepolicies and controls will help optimize the use of capital in thecompany and reduce the unnecessary costs of the leasing program.Saving money on the leasing program can help make up for some ofthe costs associated with the implementation project.

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5 Steps Underlying a Successful ASC 842 Implementation

The SAB 74 disclosures in our study show that companies arebeginning to understand the significant material impact the newlease-accounting standards will have on their balance sheet. Thefirst implementation deadlines are still several months away, somany organizations have not yet elaborated on the steps they aretaking to determine the impact. However, in the coming quarters, weexpect SAB 74 disclosures to provide more insight into how theseprojects are unfolding, as well as the potential impacts to companyprocesses, systems, and balance sheets.

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Based on our analysis of the top 100 companies as determined byoperating lease obligation, the companies that provided the mostinformation on their implementation projects are doing thefollowing:

  1. They have provided an estimate for the material impact fromtransferring right-of-use assets and lease liabilities to thebalance sheet.
  2. They have established a cross-functional project team to tacklethese standards.
  3. They have evaluated which practical expedients will work bestfor their company.
  4. They have evaluated, selected, and/or implemented alease-accounting software system.
  5. They have considered updates to processes, policies, andcontrols around leasing.

If the implementation initiative is built on these fivefundamentals, the company will be prepared to take control of theimplementation project and avoid mistakes that would increase theburden of the already overwhelming standards.

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Michael Keeler isthe CEO, president, and founder of LeaseAccelerator. An expert inlease accounting and administration, he has been the primary forcebehind the growth and vision for LeaseAccelerator since 2003.Michael has more than 20 years of experience building softwarebusinesses. Prior to joining LeaseAccelerator, he was the presidentof Onmark Corporation and founder of both DataZen and EcologicCorporation.

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