Webinar: What Controllers and CFOs Need to Know About ASC 842
Jul 16, 2019 | By John Siegel
Are you ready for the new lease accounting standards? After years of planning, the FASB has new standards that redefine leases for many companies and dramatically change how some will account for their leased assets.
To make your life a little easier FloQast recently conducted a webinar with CPAs Rosaleen Pizarro and Jeremy Brinkerhoff, managing directors at CFGI. Now, to make it even easier we’ve pulled together a few key takeaways so you can soak up some actionable insights in just a few minutes.
Here are Jeremy’s keys to ASC 842 Lease Accounting:
Embedded Lease Identification
According to Jeremy, a big shift accounting teams will need to familiarize themselves with is the concept of the embedded lease identification, or, as he refers to it, “a service contract with a dedicated fixed asset.”
“One of the things that will come up right away is embedded leases,” he said. “I like to refer to them as a service contract with a dedicated fixed asset. Think of a portion of a storage facility that’s dedicated to you or a piece of equipment at a contract manufacturer that’s dedicated to producing your goods. Think about a suite at a contract research organization, any of these.
“If you look at this list, any of the contracts on this list, most companies’ accounting pulls them as a service contract and the point of the new standard is to bring these in. When we talk about completeness, we are not simply talking about known leases: We are also talking about embedded leases.”
Discount Rate Estimation
Since the new lease standards involve booking obligations that aren’t formal leases, there is no set discount rate to use. You need to estimate a rate that’s true to your situation as accurately as possible. That’s what an estimated discount rate does.
“It is a recent, fixed-rate on a secured debt covering the company's outstanding commitments and reflecting the company's specific creditworthiness,” Jeremy explains.
Here are a few ways to arrive at that rate:
- Obtain a rate range quote from a banking contact
- Leverage a discount rate on existing debt (assuming the company’s credit standing has not changed since debt issuance)
- Estimate a discount rate using the company’s stated or implied credit rating and market analysis of recently issued debt to companies with a similar credit rating
- Utilize published capitalization rates or rates on debt financing from peer companies with similar creditworthiness
- Engage a third-party valuation specialist to assist
Choose the strategy that works best for your situation. For instance, if you’re most recently incurred debt was more than a year or two in the past, that rate isn’t likely to be accepted without support. You’ll need to show that your situation and creditworthiness haven’t changed.
If you have access to data from comparable companies, you may be able to use that to draw a conclusion. Using a third-party valuation specialist is a good solution if none of the other data can be used, but it is the most time-consuming and expensive route to estimating a discount rate.
Getting your leases in order by the deadline poses a challenge for some companies, who are already stretched with their accounting resources. To set yourself up for success in future periods, you’ll need systems and standard operating procedures (and possibly software) to update your lease obligations and discount rates. Implementing these changes will take time but following the right steps will make it easier. Jeremy pointed out four major steps or stages for implementation:
- Identifying lease activities (including those embedded leases)
- Collecting and validating data on all leases
- Determining appropriate Incremental Borrowing Rates (IBRs) for leases
- Determining day 1 entries and information needed for future comparative periods
This last point is where software can be really helpful. Moving forward, IBRs will need to be adjusted for each quarter to accurately represent the company’s creditworthiness and the current borrowing environment. Outdated rates will bring pushback from auditors and are likely to be rejected.
If you have a small number of leases — Jeremy cited 20-50 as a guideline — you may be able to complete this process manually with a spreadsheet. Any more than that will be very challenging as you continually track and update the rates for ASC 842 compliance.
Consider the software options out there to help you track your leases so they don’t consume all of your time. Look for a solution that works with your current ERP system, offers good support, and can impact other important accounting processes. Also, make sure you begin implementation of the new software well before the deadline, as it may take longer than expected. Many companies may be trying to onboard at the last minute, eating up the software provider’s support staff bandwidth.
ASC 842 is an Opportunity for Controllers
As Blake pointed out in the webinar, the new lease accounting standards are an opportunity for controllers to step into a more strategic role. Our research shows that’s the direction most controllers want to go. To get there, they’ll need more time to:
- Unearth embedded contracts with the help of multiple departments within the organization
- Educate these departments on how to recognize embedded leases moving forward
- Take ownership of the lease accounting process for the organization
The best way for controllers and CFOs to find that time and become more strategically engaged is to implement close management software like FloQast to get themselves out of the weeds of monthly closings. By saving you days off of the closing process and allowing you to monitor that process more closely, close management software gives you the freedom to step up and own the strategic side of your new lease accounting initiative.