July 17, 2019 By qiado

Top 7 challenges on Lease Accounting: Day 2

Many companies that have gone live with their Lease Accounting IFRS16 / ASC842 applications start to recognize that 1st January 2019 was a milestone, but not the finish line.

The new Lease Accounting Standards cause significant recurring efforts and add to already existing pressure in closing activities. What are the main drivers for high recurring efforts? What are the pain points after a successful cutover into the new standards? What does it take to stay compliant?

Based on our experience in hyper care and application management for major clients in different industries, we have summarized the most important aspects to consider lease accounting Day 2:

Challenge 1: The lease portfolio never sleeps

If the collection of existing leasing contracts already was a difficult exercise to get compliant with the new Lease Accounting Standards, staying compliant now requires to constantly watch out for changes to the lease portfolio:

  • A leased asset is damaged and needs to be replaced
  • A leased car changes owner / cost centre
  • Previously planned extensions are not executed or the other way around
  • Lease terms are extended or reduced
  • The scope of leasing changes, e.g. rented space is reduced
  • Rents are adjusted due to changes of underlying indexes
  • etc

With the old standards these adjustments hardly had any accounting impacts and to a large extent could be handled by the AP departments. Nowadays lease administrators need to cooperate with accountants to decide if and what consequences these adjustments have from an accounting point-of-view.

The new Lease Accounting standard implies that a company is able to identify the respective changes to its leases in the first place. Sometimes this is not that simple. For example, fleet lessors regularly provide lists of current lease contracts to their lessees. The lessee then needs to distinguish new leases from other lease events out of these data. The bigger and the more volatile the lease portfolio, the more challenging this effort becomes.

Challenge 2: Unclear responsibilities and task split

The new Lease Accounting Standards require new workflow and brings significant additional efforts to some departments. If a complex new real estate contract is negotiated, its outcome has to be “translated“ into terms and conditions that allow a calculation of the Right-of-Use value that has to be capitalized in the new standards.

But who can do that? The real estate administration? Accounting? A new service centre for contract management? Who is analysing monthly fleet lists and decides which changes have to be treated in accounting? Who needs to be informed to post an asset casualty?

Once it becomes apparent how much effort is involved in complying with the new Lease Accounting Standards, newly invented processes sometimes get questioned and might need finetuning.

Challenge 3: Bumpy month end activities

Lease Accounting adds new steps to a company’s month end closing activities. New IFRS16 / ASC842 KPIs need to be prepared for external disclosures and internal reporting.

In many organizations the days around period end are not exactly a relaxed time anyway. And the new Lease Accounting steps now create additional workload in already tight timelines. It is of essential importance that the new activities run smoothly and with proper inbuilt validations. This leads to Challenge 4.

Challenge 4: Weaknesses in tool support

None of the tools in the market have a long track-record of supporting IFRS16 / ASC842 Lease Accounting. New applications were developed that were supposed to help companies to become compliant within a tight timeline.

Many tools show their strength in handling individual contracts and contract events, but lack behind when it comes to supporting regular administrative tasks, mass processing, process monitoring or error handling.

Reducing Total Cost of Ownership (TCO), i.e. optimizing the support of recurring lease administration, will surely move into focus in the very near future.

Challenge 5: Critical latencies

Whereas accounting departments have largely been made aware of the changed processes well in advance, this was not the case in other operative units. Not every relevant process has already been adjusted and not every colleague already knows that the handling of leased assets changed now.

So, this way accounting department gets informed too late about relevant changes and has to constantly catch up events that happened weeks or months ago.

Challenge 6: User mistakes due to newness of processes

Users make mistakes. This statement is even more true in the first periods after the introduction of completely new and at the same time complex regulations.

Lease Accounting offers a broad variety of potential mistakes. Contracts can be assigned to wrong organizational units or entered with wrong currencies, financial terms can be forgotten or interpreted wrongly, wrong amortization periods might get assigned, variable lease expenses accidentally capitalized etc.

How to handle this situation?

Correcting these mistakes requires in-depth-knowledge of the financial systems involved. Especially when errors are discovered with delay and after posting periods have been closed, this becomes a challenging task. In any case, adjustments and corrections need to be treated in an audit-proof way, as they will influence an organization’s financial statements.

Challenge 7: Difficult reconciliation

Depending on the integration of Lease Accounting and procure-to-pay processes invoice, reconciliation can be a very tedious process.

In standardized and typically rather simple fleet contracts a reconciliation of invoiced amounts and due amounts according to the underlying lease agreement might not cause many issues. But in index-depending real estate agreements or complex equipment leases with partly variable lease payments and constantly changing amounts reconciliation turns time-consuming and frequently cannot be fully automated.

Additionally, if subsidiaries follow a statutory GAAP that is different to IFRS, these differences also need to be treated correctly.

The mentioned challenges are only the most common of many different operative problems a company may face after having switched to the new lease accounting standards. It turns out that the new standards cause high additional administration efforts that may not have been foreseen like that.