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The Lease Management Mistakes You Can't Afford to Make

Director at LeaseQuery Melissa Sacks discusses the uncertainty brought on by COVID-19 when accounting for leases and how lease system providers have (or haven’t) addressed these challenges.

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FEI Daily: How did public companies successfully deal with impairment assessments, significant changes in judgments, and the general uncertainty brought on by COVID-19 when accounting for leases? What can private companies learn from public companies' responses to these challenges?

Melissa Sacks: Both public and private companies had a lot to contend with as a result of the pandemic. Things were turned upside down overnight. Private companies benefited from the FASB’s ASC 842 adoption delay but shouldn’t wait until the last minute to get started. Any public filer will tell you the implementation process will be more involved and take longer than originally estimated.

Private companies can benefit from many of the issues that public companies have dealt with.  As private companies move toward the transition to ASC 842, adoption items like evaluating the available practical expedients will, of course, need to be considered. A large focus should also be put on Day 2 accounting and process changes. Items like knowing when to assess the ROU asset for impairment, when to reassess discount rates and something as simple as the AP process all require your attention now. Utilize all of the great resources out there around the transition to ASC 842. There is a ton of content on lessons learned and best practices for a successful implementation.

FEI Daily: Some public companies have reported challenges around lease disclosures, such as disclosures around variable lease payments and costs. What are the major disclosure challenges and pitfalls that private companies should be aware of?

Sacks: One thing to keep in mind is just the sheer volume of required disclosures under ASC 842. The amount of items to disclose increased substantially from the required disclosures under ASC 840 and some of the disclosures will involve calculations like weighted average lease term and discount rate. Private companies are likely focused on Day 1 (i.e. transition date) accounting right now - bringing the liabilities on balance sheet and estimating that amount. It’s important to also be prepared for the entire adoption year not just transition. As you’re evaluating vendors or preparing your own lease schedules think about how you will summarize and aggregate this information into the necessary disclosures.

FEI Daily: Discount rates are a complex part of ASC 842. What are the key considerations that private companies should take into account when determining and documenting discount rates?

Sacks: The good news for private companies is that discount rate application relief not available to the public companies is available to them. Currently, private companies have the option to apply the risk-free interest rate to their lease portfolio. And just last week, the FASB voted unanimously to allow non-public entities the option to use the risk-free rate at an underlying asset class level (rather than for the entire lease portfolio). The exposure draft addressing this amendment is expected in June and a final ASU will be issued well in advance of the looming January 1, 2022 deadline for most private companies.

Another item to consider is the use of the portfolio approach for the application of discount rates. This option was also available to public companies and was widely applied. Essentially, this means that instead of applying discount rates on a lease by lease basis, leases can be grouped together by underlying asset class or lease contract duration and applied universally.

FEI Daily: When implementing and applying ASC 842, what system limitations or challenges did public companies face? How have public companies and lease system providers addressed these issues, and are there any existing system limitations or challenges that private companies should be aware of?

Sacks: Most of the large lease accounting vendors out there were extremely prepared and well equipped for the public filers’ transition to ASC 842. At LeaseQuery, we’ve used our experiences from helping more than one thousand of companies transition to ASC 842 to build out our teams and training materials to provide the best possible experience for those companies who haven’t transitioned yet. We’ve taken what we learned from our customers and applied that directly in our software - from improving workflows and adding additional tool tips to providing more customer bulletins and webinars. We think this will pave the way for a successful implementation for all of our customers who haven’t adopted yet. One other thing to emphasize is the importance of a system that’s purpose built for lease accounting compliance. We have several customers who initially went with an older lease management system that sort of tacked on a lease accounting solution and that just doesn’t work. You want a system that can deliver what you need it to do.

FEI Daily: Based on your opinion and experience researching SEC comments, what are the most challenging areas of judgment that public companies have faced in applying ASC 842? What can private companies learn about these areas from public companies?

Sacks: We’ve seen a lot of attention around items like discount rates, materiality, and financial presentation in general. Discount rates are a vital part of ASC 842 because they directly affect the dollar value of the lease liabilities recorded on the balance sheet.  There is scrutiny over how incremental borrowing rates are determined and the lessee’s use of the implicit rate. The SEC is pushing back on filers asking for documentation on the determination of these rates and re-iterating that the implicit rate is rarely appropriate for the lessee. For companies who checked the box on immateriality, the SEC wants to know the facts and the dollar values that make it immaterial. Finally, financial statement presentation of the lease liabilities and ROU assets is something we’ve seen the SEC dig into. Specifically, the SEC has inquired of companies who combined the lease liabilities for operating and finance type leases into the same line item (not permitted) and the presentation of the cash flow impacts of leases. Private entities, if they haven’t already, should start thinking about items like revisions to the chart of accounts they’ll need to make to accommodate ASC 842 and how the impacts of ASC 842 will be presented in the financial statements.