Public companies reached the deadline for compliance with the new lease accounting rules in January, but their journey is far from over.
A recent survey of 200 accountants found that just 54 percent of public companies are fully transitioned. Deloitte data paints an even more dire picture: Only 26 percent of public company executives reported that their implementation was complete. The reality is that leases remain a sore spot for many. According to CB Insights, lease accounting was mentioned 621 times in Q2 earnings reports, up from 35 in Q2 2018.
If you ask public companies about their transition process, most will tell you it was more difficult and more time consuming than they anticipated. In many cases, compliance came by brute force rather than optimized systems. As a result, the road that many public companies took to meet the deadline is not a path they want to repeat. A recent Robert Half study found that 95 percent of respondents said they plan to change their approach to lease accounting compliance in the future.
As the fallout from one of the most significant regulatory changes in 40 years continues, here are the key challenges public companies are still grappling with.
One key reason lease accounting was so frequently discussed in earnings reports is that public companies must now explain key changes to their results. Public companies have noted that comparisons to the previous year’s results are now difficult to make. They have reported large one-time impairment changes, and they have worked to explain fundamental changes to their balance sheet that will impact how their results look moving forward. Changes to cash flow and EBITDA are also key issues that will pose ongoing challenges to public companies. We’re only in the early days of seeing how some of these changes to reporting and metrics could impact areas like valuation and M&A terms.
While increased transparency to investors and analysts is a positive outcome, in these first periods under the new rule, public companies will need to continue to be clear and diligent about communicating the factors behind differences in results and reporting.
Optimizing people, processes and controls
Getting to compliance in a short time frame created some suboptimal systems. Now that the deadline has passed, companies are reassessing their resources and processes to seek more optimization and efficiency. In many companies, leases were decentralized, and new committees and protocols were formed to document and categorize the full lease portfolio. Public companies now have a chance to take a step back and determine whether their means of internal collaboration and documentation are optimized, whether their data is accurate in real time, and whether they have the right controls to identify errors. Many public companies also leveraged a software solution to help identify, categorize and report leases and found that their choice was not fully compliant with the new rules. Indeed, FASB called out some lease accounting software providers for their lack of readiness, citing these shortcomings as one reason for the recommended deadline delay for private companies and nonprofits.
As public companies reassess their lease accounting processes for optimization, they should conduct a software review to ensure they can achieve continued compliance and the appropriate accounting outputs as leases are changed or modified during the normal course of business.
The benefits of the new lease accounting rules for investors and financial statement users have been heavily promoted, but the benefits for compliant companies have been overlooked. When lease accounting implementation is done right, it’s not just an exercise in compliance, it’s an opportunity for actionable business insight. If public companies simply work toward compliance and then move on to other priorities, they will miss the potential to optimize their entire real estate and leasing strategy. When a company’s leases are properly documented and centralized, there is a wealth of business insight to be gained. Companies have uncovered cash they were leaving on the table by not closely monitoring lease terms, and they have identified data that gives them more negotiating power. New lease classification rules are also leading some companies to reevaluate their buy vs. lease decisions and set optimized terms for the leases they do take on.
As public companies continue their 2020 business planning, many would probably love to wash their hands of lease accounting and move on. But the butterfly effect of the changes means there is more work ahead. The good news is these additional efforts will lead to greater transparency internally and externally, more efficient processes, and better business intelligence for strategic planning.