Key Steps to the Lease Accounting Close
While some organizations have transitioned smoothly, others are still struggling to make the necessary business process and control changes.
To comply with the new lease accounting standards, organizations have had to implement new business processes, new organizational structures, and new information systems. Most organizations have muscled through the first year of adoption using a combination of brute force and high-priced consultants. However, those approaches will not scale over the long term.
The technical accounting changes promulgated under the new standards are just one aspect. Accountants will have to make significant judgments to conform with the new lease accounting rules. Those judgments must be regularly re-evaluated and updated as facts and circumstances become known, and contingencies resolved.
Reassessments and remeasurements of recorded lease assets and liabilities are now a commonplace event, often occurring every month. Compared with the historical close process used under the legacy leasing standards, ASC 840 and IAS 17, several procedures have been added to the record-to-report processes. There are new quantitative and qualitative disclosers, new general ledger accounts, and new controls required. However, the most cumbersome new procedures fall on the teams outside accounting. Many may be new to accounting and the new standards.
Some large companies have hired new staff to close the talent gap; smaller organizations are relying on general accounting staff to handle leasing. In both instances, many accounting teams are still using unreliable spreadsheet models, system hacks, and manual reconciliation processes to arrive at the complete set of monthly journal entries needed for the close.
Ultimately, success with lease accounting will require organizations to transition to a highly automated record-to-report process. That process should include a consistent, repeatable close that fits into the overall corporate reporting timeline, as the new standards require lease accounting at the asset level.
Eight Steps
With these challenges in mind, we have outlined the eight key steps that organizations will need to focus on.
1. Master data updates — The lease accounting system will need to be updated regularly with new master data. Examples include changes to general ledger codes, cost centers, tax rates, depreciation methods, economic lives, foreign exchange rates, incremental borrowing rates, credit ratings, and debt weights. Other updates might include the addition of new physical locations, new asset types, and new lessor relationships.
2. Account maintenance — The general ledger accounts, company profit centers, or cost-center splits associated with different assets might change during any given accounting period. As a result, the profit center associated with the asset will need to be updated. For most companies, the more significant challenge will not be making the updates to the system, but rather identifying that a change needs to occur.
3. Event procedures — On average, 50% of a typical lease portfolio changes during any given year. The company signs new leases, payments change, the lease term extends or is terminated early, and assets are added or removed to or from a lease. Contracts are modified, others expire, renew, or terminate. Ensuring the completeness and accuracy of the lease portfolio will require robust event procedures at month-end close to perform commencement, termination, and modification accounting.
4. Control procedures — During the close process, a series of control procedures should be executed to verify the accuracy and completeness of the accounting. The kinds of controls will vary, but most will design procedures to address the areas of highest inherent risk and those that potentially breach materiality thresholds. Typical areas of focus include IT general controls, confirming the accuracy of inputs to and outputs from systems; validating judgments, estimates, and assumptions used; and reconciliations between the general ledger and the sub-ledger.
5. Posting of entries and reconciliation — Once the detective control procedures are completed and the lease portfolio deemed to be complete and accurate, the final journal entries should be prepared for upload to the general ledger. Organizations will need to weigh the costs and benefits of different approaches ranging from fully-automated system-to-system integration to a manual file extract and upload through the user interface. Companies with multiple ERP platforms may need to use several different approaches to ensure the journal entries are posted correctly to the GL.
Once the entries are posted to the ERP, the reconciliation of the balances of all lease accounting general ledger accounts in the ERP must be done to the lease accounting sub-ledger. The best practice is to reconcile in transaction currency, functional currency, and reporting currency.
1. Disclosures — The new lease accounting standards require significant and meaningful new quantitative and qualitative disclosures not found under the old standards. Some organizations will have more complex disclosure requirements that require modeling and reporting in a spreadsheet; for example, segment or business unit reporting. Others that have statutory reporting that does not align with their fiscal calendar may require customized reporting strategies to comply. Many qualitative disclosures, such as assumptions, judgments, policy elections, practical expedients, and general descriptions of the lease population, are unlikely to change frequently. However, companies will need to ensure that new contracts and modifications identified during the event procedures (e.g., sale/leasebacks) are included as appropriate.
2. Close — Once all accounting and disclosure reporting is completed and the reconciliation with the general ledger is complete, the sub-ledger can be closed. Some organizations may perform a soft close before completing activities such as control testing or disclosure generation.
3. Post-close adjustments — Following the close, teams should revisit event procedures to identify any changes to the lease portfolio that not captured in the prior period’s accounting. Organizations with a longer duration between the time of sub-ledger cutoff and the overall close will likely have more new leases, contract changes, and terminations to evaluate.
The new leasing standards, which took 10 years to be issued by the respective boards, are one of the most significant accounting changes in history, affecting almost every company subject to an external audit. While some organizations have transitioned smoothly to these standards, others are still struggling to make the necessary business process and control changes. Many are re-evaluating their systems approach to make greater use of technology to manage the leasing lifecycle and automate financial reporting. Those who have found early success, and will continue to do so, have adopted solutions that provide an automated record-to-report process that includes a consistent, repeatable close process. It also ensures that company policies and procedures are applied on a consistent basis over the entire lease portfolio.
(Source: AICPA - CPA Letter - Daily CFO - January 28, 2020)