Impact of the new lease accounting standards
A data and change management challenge: Is your budget ready?
This article gives insights to management of companies reporting under IFRS to understand the impact of the new lease accounting standards (IFRS 16 and ASC 842). The impact of complying with these new standards is bigger than most would imagine. Sir David Tweedie (former IASB Chairman) describes the main difference between the old and the new IFRS standard: “One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet” . The companywide impact, originating from IFRS 16 and ASC 842, is massive, often misjudged and underestimated.
- The new lease accounting standards
- Data accuracy and completeness
- Automating your lease accounting
- Business process re-design
- More information?
Apart from the accounting impact on the annual accounts, the new lease accounting standards embody a large data management challenge on top of the ordinary change management efforts. Whereas data management means properly managing the full data lifecycle needs. For reporting of leased assets, lease obligations and costs, more insight in the company’s existing lease contracts is needed than currently often maintained. Therefore, new data needs to be abstracted from the source documents, enriched and maintained in order to achieve proper compliant reporting under the new lease accounting standards. The difficulty is not just the calculation, but gathering the data to base the calculation on.
Abstracting the data from the source documents, being the lease contracts, is one of the biggest challenges for compliant reporting. Challenges are:
- Location of lease contracts – We see that companies do not know where the contracts that could potentially contain leases are located, or where lease contract data are recorded, if recorded at all. And how is completeness assured? Contracts are spread over countries, operating units, legal entities, languages and lease categories. In binders, boxes or in PDFs, but are they completed with the latest amendments to those contracts? All variables will cause a different way of accounting and thus create the risk of non-compliance.
- Language of lease contracts – When in a global environment with more than one language, lease contracts in more than 10 languages are no exception. Abstracting the data needed can therefore be challenging and is often very labor intensive.
- Formats of lease contracts – When considering the variety in formats of lease contracts, no contract is alike, even more so when considering the asset class leased.
- Digital or written – More complicating, contracts are in all forms of writing. Ranging from structured data points, PDFs and Word documents up until hand-written end manually amended contracts. In that case, an OCR (optical character recognition) enabled data extraction method is proven to be challenging, even in the most fortunate cases in which data is already digitally available.
- Audit trail - Only after completing the contract gathering and data capturing, companies might encounter their internal or external auditor asking for the audit trail that assured the completeness of the lease population and data gathered.
- Financial system – Lastly, the current financial systems cannot deal with the new lease accounting standards calculations and third party software might be needed. And we all know implementing software might just be another challenge added to the list of challenges.
Data accuracy and completeness
At first, data needs to be abstracted from the underlying lease contracts themselves. Within the database, data needs to be administrated in a structured way, matching the way of further automating the calculation and the related data points needed. The accuracy and completeness of data needs to be validated to properly calculate in a later stage. Furthermore, an auditable testing and validation process of data needs to be implemented.
Automating your lease accounting
Different data points need to be abstracted from the contract for potentially compliant reporting. To enable consolidated reporting, abstracted data needs to be stored in a structured and pre-defined way.
Furthermore, data outside the contract needs to be added. For instance, discount rates, cost centers or management judgement on termination, extension and purchase options, enriching the database and enabling reporting.
When accounting for a small population of lease contracts, Excel might seem a solution, if you do not mind adding internal controls on version control and monitoring procedures. However, when accounting for a larger population of lease contracts, lease software is in order, simply because of the maintenance needed on those contracts and the data it encompasses, during a certain period.
Business process re-design
In relation to the foresaid, another challenge presents itself. IFRS 16 and ASC 842 are effective for calendar years starting on or after 1 January 2019 and are here to stay. This means that analyzing lease contracts should be part of daily procurement processes. Implementing these processes is part of the conversion - the conversion should not be treated as a onetime exercise. The present procurement process needs to be altered, amended and perhaps replaced. A change management process is to be expected.
This article discusses insight in the proposed steps to be taken in order to be compliant by 1 January 2019. A realistic image is given of the implications IFRS 16 and ASC 842 will have worldwide. The impact is not solely limited to accounting and the finance department, composing the annual accounts. In order to reach the goal of compliant reporting supported by an unqualified audit opinion, a lot of work is to be done. The work ranges from setting up data management to business process redesign for a fairly unknown class of transactions.
Want to know more on IFRS16 and ASC 842? Please contact Anthony Maalsté or Göran Vernooij via the contact details below.