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New Lease Accounting Standards Require Advance Planning and Preparation by Whitney K. Schiffer, CPA

Posted on October 03, 2018 by Whitney Schiffer

Businesses across all industries are facing a serious time crunch to come onto compliance with two new accounting standards that will materially affect the financial metrics and performance they report in the future. While most private companies have focused the majority of their efforts on meeting the more time-sensitive deadline of Dec. 15, 2018, to apply the new revenue recognition standards, many are woefully unprepared to tackle the equally complex and time-consuming lease accounting requirements that go into effect one year later.

The new lease accounting standard requires businesses to identify and record for the first time on their balance sheets all operating lease agreements, including assets, liabilities and expenses with terms greater than 12 months. In addition to recording a right-of-use asset and the corresponding lease liability on their balance sheets at the present value of the lease payments, business will also need to record amortization of the right-of-use asset on their income statements, generally on a straight-line basis over the lease term.

From an organizational perspective, identifying qualifying leases necessitates commitments of time, careful planning and collaboration across many business units beyond the finance and/or accounting functions. For example, it is not sufficient for businesses to merely look back at last year’s financial statements and convert leases previously included in notes as line items on their balance sheets going forward. Instead, identifying leases will internal executives and external advisors who oversee real estate, transportation, equipment procurement, legal contracts and IT across multiple offices to physically comb through all of the existing contracts and purchase orders in their physical and digital file cabinets to determine if they involve lease arrangements. Under certain circumstances, the existence of a lease may be not be easily identifiable. For example, service contracts for IT software and systems commonly include embedded leases, which businesses may easily overlook and fail to include on their balance sheets.

After a business locates every single one of their qualifying leases, they must inventory those arrangements with exacting detail, perhaps on a spreadsheet or entering them into any of the new lease accounting software programs that store and automate the future reporting requirements for those and other leases. At that point, the business must analyze each contract and extract from each individual lease arrangement all relevant data, including lease payments, variable lease payments, debt obligations and lease renewal options, which must move onto the balance sheet. This can be a challenge considering that not all employees tasked with uncovering leases will have the skillset required to cull needed information from those contracts, nor will every employee understand the potential risks or rewards of those arrangements.

For businesses with significant portfolios of leased assets, transitioning to the new lease standard may negate and eliminate the use of many of the tax-planning strategies they relied on in the past to keep leases off their balance sheets. Additionally, businesses with a high-dollar value of lease obligations must be mindful that the new accounting standard may result in substantial changes to the net income, cash flow, return on assets and other metrics that they report and that they and their stakeholders rely on to make important business decisions. To minimize the impact of these balance sheet changes, businesses must begin planning immediately and carefully to identify with as much accuracy as possible the amount they expect to record as lease assets in the future. This will give businesses ample time to prepare for the changes, communicate them with stakeholders and seamlessly implement new strategies to mitigate any potentially damaging effects on their future operational and financial performance.

A final warning to businesses preparing for the new lease accounting standards is the need to establish appropriate systems, policies and controls for monitoring existing leases, flagging new lease arrangements and recognizing them on their balance sheets in the future. This may require an investment in new technology, the hiring of new employees and/or the engagement of outside advisors who are qualified to manage these responsibilities.

There is no doubt that the lease accounting standards will add new complexities to a broad range of business functions, including sales, lending, contracting and financial reporting. However, under the new rules, businesses will be able to centralize the inventory and management of all lease arrangements and gain a clearer view of whether those assets are improving business performance.

Coming into compliance with the new lease standards by the deadline date may seem overwhelming, especially in light of the multitude of pressures businesses face complying with other new reporting standards, the new tax laws and the day-to-day demands of running a profitable operation. However, there is little time left for procrastination. Business should allocate needed resources now to get started on implementing a scalable lease accounting compliance program that is sustainable over the long term. One way that businesses can ease their compliance burdens is to meet with their accountants and auditors, who can develop and implement strategies that may ultimately improve financial performance.

About the Author: Whitney K. Schiffer, CPA, is a director of Audit and Attest Services with Berkowitz Pollack Brant, where she works with hospitals, health care providers, HMOs, third-party administrators and real estate businesses. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.

Artificial Intelligence Improves Audit Function, Helps Businesses Save Time and Money by Hector Aguililla, CPA

Posted on September 12, 2018 by Hector Aguililla

Artificial intelligence (AI) is quickly becoming a mainstay of our lives, helping us to control the appliances in our homes, recommend movies or products based on our previous behavior, and take us on rides in self-driving cars. Similarly, AI has crept into the corporate environment, helping to sort through the voluminous amounts of data created by the new breed of software and systems that businesses large and small use to manage their operations. When it is combined with expertise of professional auditors, AI helps businesses enhance the audit processes, improve efficiencies and reduce costs.

Audits historically involve a qualified third-party professional’s objective assessment of all of an entity’s financial records, documents and processes to ensure the business presents a fair and accurate representation of its financial position to all of its key constituents, including senior management, board members, investors and lenders. They can help businesses prevent and detect fraud and noncompliance with government regulations and validate the credibility of information that stakeholders rely on to make informed decisions about the organization’s direction and long-term growth.

Combing through thousands of records and transactions to identify potential issues and/or hidden opportunities that can affect business performance requires the specialized skills of highly trained auditors. While the proliferation of software programs that automate business processes and documentation has helped to expedite auditors work, AI and machine learning go even further, helping businesses reap significant savings of time, money and resources for their investment in audit services.

AI saves businesses time by automating many tedious and repetitive audit tasks. It can continuously collect and process the massive amounts of data businesses create, learn and predict acceptable patterns of behavior and algorithms, and identify anomalies and trends between seemingly unrelated activities as they occur in real time. As a result, when AI is embedded in the audit function, businesses have an easier time staying on top of all their audit risks throughout the year and are able to respond immediately to potential threats rather than waiting for a suspicious transaction to be identified during their next external audit. Similarly, business can also use AI to monitor the day-to-day progress of specific strategies and initiatives by flagging those activities or behavior patterns that either differ from an established plan or fail to occur at all.

AI also helps businesses improve reporting accuracy by downloading data directly from existing accounting software systems and legal contracts and even linking line items on financial statements or accounting ledgers to supporting documentation, such as invoices or cancelled checks. Not only does this minimize the risk of human error, it also helps businesses account for every line item and maintain compliance with a multitude of constantly changing rules and regulations. Moreover, AI can provide auditors with the ability to assign weight and priority to specific risk factors and narrow in on specific threats that may be inherent or specific to a particular line of business or industry. For example, an external auditor is required to test journal entries.  Using AI software, an auditor is able to sift through 100% of all journal entries made during the period being tested to produce a risk score for each transaction to highlight those for further investigation. Sifting through 100% of journal entries would take an excessive amount of time not using AI software.

To be sure, the application of AI in the audit processes is both practical and affordable. However, it does not eliminate the need for external auditors, nor does it replace the professional assessment and judgement that only humans can bring to data analytics. After all, not all business metrics are black and white. There are often nuanced factors that companies must identify and take into consideration before making important decisions that can affect their business operations. This responsibility should remain in the hands of professional auditors who understand and know how to leverage big data and AI to bring meaningful insight, improved efficiency and greater confidence to business decisions and high quality audit services.

About the Author: Hector E. Aguililla, CPA, is a director with Berkowitz Pollack Brant’s Audit and Attest services practice, where he provides business consulting services, conducts audits, reviews, compilations, and due diligence for mergers and acquisitions. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.

How Can Real Estate Businesses Prepare for the New Model of Revenue Recognition? by Robert C. Aldir, CPA

Posted on November 10, 2017 by Robert Aldir

The new model for how businesses across all industries will need to recognize revenue from customer contracts in 2018 for public companies and in 2019 for nonpublic companies is a game changer. While privately held companies have an additional year to come into compliance, they must begin preparations now to account for the substantial changes in the timing and amount of income and expenses they will report on an annual basis in the future. Moreover, adopting the new standard will bring with it significant complexities that will impact virtually all areas of a business’s operations, including contracting, sales, lending and financing, information technology, policies and procedures, and financial reporting.

Unlike the current requirements under the U.S. Generally Accepted Accounting Principles (GAAP), the Accounting Standards Update (ASU) No. 2014-09 provides businesses in all industries and all jurisdictions with one singular and consistent five-step model for recognizing and reporting the “nature, amount, timing, and uncertainty of revenue and cash flows arising from a contract with a customer.” More specifically, the new model represents a shift from more rules-based accounting standards toward one that will require businesses to assess the unique facts and circumstances of each customer contract and exercise significant judgment when determining the amount and timing of revenue recognition. This will be especially difficult for businesses in the real estate and construction industries to navigate and may lead to devastating consequences if they do not apply judgment in a manner that is consistent with the new model.

Step One: Identify the Contract with a Customer

Under the new regulations, a contract will exist when there is an agreement between and approved by two or more parties that creates and specifically identifies both 1) the enforceable rights to goods and services and 2) the related payment terms, including transaction price, which an entity can expect to collect in exchange for delivering those goods and service. While this definition appears simple and precise, it is important for businesses to understand that there are nuances to a contract that could create a separate and distinct contract or significantly modify the terms of an existing contract.

For example, in the world of real estate, a change order can, in some instances, create a new, separate contract. Similarly, the collectability factor of a real estate contract can be a complicated judgment call, especially when an entity offers pricing concessions or seller-provided financing to the customer.

Should it be determined that a contract does not exist based on the new revenue recognition standard, an entity will need to report all payments it received as liabilities until the point in time when all parties meet their contractual obligations.

With these concerns in mind, it is critical that real estate businesses engage the services of experienced legal counsel to properly draft contract agreements that meet the requirements of the new regulations and to explain how the new standards will affect when and how they recognize revenue. This will not only impact a business’s bottom line and create disparities between similar real estate companies, it will also have significant influence over a business’s loan covenants and access to capital.

Step 2: Identify the Performance Obligations

Performance obligations are contractual promises to deliver to a customer distinct goods or services or a combination of goods and service. While there are specific rules for defining performance obligations, the key challenge for most businesses will be identifying whether multiple performance obligations are distinct from each another in the context of the contract.

In the real estate industry, a single contract may include multiple performance obligations. For example, a developer building a condominium tower may contract to construct and sell individual units. It may also promise to provide customers with amenities, such as pools and tennis courts, extended warrantied for appliances and building maintenance and/or management services. In this example, the developer must first have systems in place to more easily capture and identify all distinct performance obligations and related stand-alone costs that they would need to carve out from their existing sales contracts.

In some instances, businesses may need to bundle together multiple services into one performance obligation. In other situations, goods and services may need to be unbundled into separate obligations. This would undoubtedly alter when the developer may recognize revenue from each good and service it delivers, and it would require the assistance of certified accountants to make an educated judgment and project the actual financial impact these changes would create.

Step 3: Determine the Transaction Price

Determining the transaction price, or the amount that real estate developers can expect as payment in return for transferring goods or services to a customer, requires consideration of following elements: non-cash considerations; pricing discounts, credits, price concessions, returns, or performance bonuses and penalties; the existence of significant financing components; and consideration payable to the customer. Ultimately, each of these factors will impact the final numbers.

In real estate deals, it is not uncommon for a transaction price to be less than a contracted price. This is especially true when there exists a contract concession that affects when and how much revenue a business may account for in the transaction price. Under these circumstances, a business will need to use an appropriate method to estimate at the time of contract the discounts and ultimate transaction price it is entitled to receive at the end of each reporting period. This will require businesses to develop new models for projecting revenue in the future as well as updating their current forecasts. In some instances, recognition of revenue may be accelerated or delayed when compared to current requirements under GAAP.

Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract

To allocate an appropriate transaction price to each performance obligation, a real estate business must first determine at contract inception the stand-alone selling price of each distinct product and service it promises to deliver. For example, the real estate developer building a multi-family apartment project with clubhouse, park and retail facilities, would need to allocate the total contract price to each separate performance obligation (i.e. the multi-family homes, the clubhouse, the park and the retail facilities).

These prices may not be easily recognizable due to volume discounts or bundling. In these instances, businesses will need to develop new processes and procedures for estimating stand-alone selling prices of the goods and services to be delivered.

Step 5: Recognize Revenue When (or As) the Entity Satisfies a Performance Obligation

Under the new standard, real estate businesses will no longer recognize revenue when they transfer the risks and rewards of ownership to a buyer. Rather, they will account for revenue when they fulfill a performance obligation, either at a point in time or over an extended period of time.

Under the ASU, businesses will need to evaluate whether or not they satisfied a performance obligation (and can, therefore, book revenue) based upon 1) the customer’s rights to the benefits provided by the contract, 2) whether or not the businesses created or enhanced an asset that a customer controls, and 3) whether or not the businesses created or customized an asset that only the customer can use and has an enforceable right to payment for performance completed to date.

Applying these methods of measurement for satisfying an obligation that occurs over time further requires businesses to identify the moment at which they transfer control, which may be when the customer accepts the asset and takes significant risks and rewards of ownership, when the customer takes physical possession or legal title to the asset, or when the business has a present right to payment for the asset.

Consider, for example, a property management company with contracts that contain multiple performance obligations that they perform for one contract price. Certain performance obligations, such as property maintenance and repairs, will be delivered over time. Others, such as leasing services, will be performed at one point in time. Under the new standard, the company would be required to allocate the lump sum of its “transaction price” between these separate performance obligations.

Privately held businesses in all industries, including real estate and construction, have a narrow window of opportunity to plan and prepare for the new model of revenue recognition, which will go into effect on Jan. 1, 2019, for annual reporting entities. The first step should be a meeting with legal and tax advisors and accountants to understand how the new standard will ultimately impact an organization’s existing processes, policies, systems, and profits.

 

About the Author: Robert C. Aldir, CPA, is an associate director of Audit and Attest Services with Berkowitz Pollack Brant, where he provides accounting, auditing and litigation-support counsel to public and privately held companies located throughout the world. He can be reached at the firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.

First Steps to Tackling the New Model for Revenue Recognition by Christopher Cichoski, CPA

Posted on July 20, 2017 by Christopher Cichoski

Businesses large and small and across virtually all industries face a perfect storm of financial reporting compliance challenges to contend with in the coming months. On the near horizon are the new revenue recognition standards, which go into effect for public companies, employee benefit plans and certain not-for-profit entities beginning after Dec. 15, 2017, and Dec. 15, 2018, for private companies. The new method for recognizing revenue from contracts with customers can be a heavy compliance burden on affected businesses. Among the challenges business will face are significant investments of time, resources and coordination across multiple business functions to review how the new standard will affect their financial reporting in the future and potential requirements to change existing contracts, business policies, practices and technology – all while maintaining normal business operations.

 

Rather than watching the clock count down and awaiting industry-specific implementation guidance from the American Institute of CPAs (AICPA), businesses should be taking the following steps now to make the eventual transition as smooth and seamless as possible.

 

Understand the Basics of the New Model of Revenue Recognition

In 2014, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) introduced ASU 2014-09 to simplify how businesses in different industries book revenue for similar transactions and ensure that they present their financial results in a manner that is comparable across all industries and capital markets. The new model does away with disparate industry- and transaction-specific financial reporting requirements in favor of a more principles-based approach that businesses in all industries and countries will use in the same consistent manner to report the “nature, amount, timing, and uncertainty of revenue and cash flows arising from a contract with a customer” in the same consistent manner.  More specifically, the model requires businesses to take the following five steps:

 

  1. Identify each customer contract
  2. Identify each and every “distinct performance obligation”, or separately identifiable goods and services, they promise to deliver
  3. Determine the transaction price(s) they “expect to be entitled to” under the terms of the contract
  4. Allocate the transaction price to each separate and distinct performance obligation
  5. Recognize revenue when the entity satisfies each separate performance obligation

Ultimately, businesses will need to identify each distinct product and/or service they provide and determine when and for how much they can recognize the proportionate revenue from each individual obligation contained in each separate customer contract. Despite the universal application of the five-step model, businesses will be impacted differently from one company to the next and from one industry to another.

 

Develop a Team to Spearhead the Process

Do not make the mistake of assuming that the new standard of revenue recognition is merely an accounting or finance issue. Rather, businesses of all sizes should recognize the impact the new rules and how they must recognize revenue in the future will have on all of the people, processes and systems throughout their organizations, including sales, IT, legal, accounting and financial reporting.

 

Remember, this is a marathon, not a sprint, and it will require significant amounts of time and teamwork to gather and analyze information, assess the impact of the new regulations on their current operations and make needed adjustments. For example, compliance with the new standard may require businesses to change their pricing structures and sales incentives, as well as employee compensation and the IT systems that manage and control these functions.

 

Assess Contracts with Customers

Gathering and analyzing information related to all of a business’s existing contracts is pivotal to implementing the new regulations. For one, businesses may find that existing contracts based on currently acceptable “persuasive evidence of an arrangement” will not qualify as contracts with customers under the new regime of revenue recognition, which requires that all of the following conditions be met:

·        The agreement specifies the legally enforceable rights and responsibilities of both the buyer and the seller, including the payment terms for the transfer of goods and/or services

·        Both seller and buyer approve the contract (in writing or orally) and agree to perform their respective contractual obligations

·        The agreement has commercial substance, for which both buyer and seller can expect their respective cash flow to change as a result of the transaction

 

Identify Distinct Promises for Goods and Services

Under the new standard, businesses must determine, within the context of customer contracts, each separate and distinct good or service they promise to transfer to the customer as well as the timing and amount of revenue they may recognize from each individual obligation contained in the contract.  More specifically, the regulations define “distinct” goods and services as those in which

1.     the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer or

2.     The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract

 

In other words, businesses must determine whether they promise to transfer each good or service individually or as combined goods and services. For example, a business may integrate and bundle together multiple promises for goods or services (inputs) to deliver to the customer one combined output. Similarly, multiple goods or services may be interdependent or interrelated with each other, such is the case with software and subsequent updates, for which two or more goods or services may be combined into one promise to transfer goods and services. In some situations, a business may find that contract components that they previously bundled together should be identified separately under the new regulations.

 

Yet, there are times when a contract with a customer may include “implied” promises to transfer goods or services that are not explicitly identified in a contract as separate performance obligations. Rather one or more phases, elements or units of a performance obligation may be bundled together into one combined output(s). For example, if a business performs shipping and handling services to fulfill its obligation to transfer ownership of a product to a customer, those activities will not be considered separate performance obligations that would otherwise require additional contracts. Therefore, the seller may recognize revenue from the sale of a product at the time that it ships the good to the customer.  Conversely, if a seller, under its normal business practices, has a history of reimbursing customers for goods that have been lost or damaged in transit, it may consider this coverage of risk to be a separate services for which revenue may be recognized only after the customer physically receives and accepts the product.

 

Generally, the following factors will indicate that two or more promises to transfer goods or services to a customer are not separately identifiable:

1.     The entity provides a significant service of integrating the good goods or services with other goods or services promised in the contract.

2.     One or more of the goods or services significantly modifies or customizes, or are significantly modified or customized by, one or more of the other goods or services promised in the contract.

3.     Each of the goods or services are highly interdependent or highly interrelated in ensuring the seller can fulfill its promise to transfer each of the goods or services independently.

 

Know When to Recognize Revenue

In order for a business to recognize revenue from performing a particular performance obligation, the following criteria must be met:

·        The seller transfers title and delivers the product or services to the customer, who accepts the goods and services along with the risks and rewards of ownership

·        It is probable that the seller will receive payment for the transaction

·        The “amount of revenue can be measured reliably”

·        The seller substantially completes or fulfills the terms specified in the arrangement with only inconsequential obligations remaining.

 

Businesses will need to consider a myriad of issues that can affect these requirement, including, but not limited to, the definition of title transfer, customer acceptance and substantial completion of contract terms; the effect of undeliverable products, customers’ rights of return and refunds on their recognition of revenue; and sales involving “multiple element arrangements” for which the new method for recognizing revenue may need to be applied to each distinct obligation separately.

 

Consider Non-Revenue Impact

Depending upon the industries in which businesses operate, the new standard for recognizing revenue from customer contracts could have significant impact on their non-revenue financial reporting.

 

For example, product-service warranties that businesses offer customers will need to be treated under the new regulations as separate performance obligations for which revenue allocation will change from current practices. In addition, businesses may be required under the new standard to capitalize and defer recognition of certain costs that they currently expense and record in the current year. This may allow businesses to depreciate or amortize over time the costs they incur for direct labor and materials, bids, sales commissions and subcontractors.

 

Similarly, the new standard will change the way in which businesses treat sales of non-financial assets, such as real estate, property, plant and equipment, outside of their normal and customary business activities. The timing and measurement of the gains and losses from these sales, which businesses will recognize separately on their financial statements, may be different from current practices.

 

When considering the impact that the new regulations will have on the recognition of revenue it is reasonable to assume that it will also affect the timing and amount of taxable income the business will report.  As a result, businesses should begin thinking now about potential revisions they will need to make to pricing arrangements and all internal controls related to income tax accounting.

 

This assessment of customer contracts and different performance obligations can be a daunting challenge, especially for small to mid-size businesses that do not have in place the appropriate systems required to analyze and dissect this information. The same is true for bigger businesses with very large numbers of customer contracts and sources of revenue, some of which may be combinations of bundled products and services, including discounts, licensing fees, interest and dividends, royalties and rent.

 

The advisors and accountants with Berkowitz Pollack Brant work with businesses across all industries to develop and implement strategies that meet ever-changing financial reporting and disclosure requirements.

 

About the Author: Christopher Cichoski, CPA, is a senior manager in the Audit and Attest Services practice with Berkowitz Pollack Brant, where works closely with business clients in the real estate and construction industries as well as with non-profit organizations.  He can be reached at the Miami CPA firm’s office at (305) 379-7000 or via email at info@bpbcpa.com.

6 Strategies to Help Businesses Prepare for New Lease Accounting Rules by Whitney K. Schiffer, CPA

Posted on May 03, 2017 by Whitney Schiffer

Time is ticking away for businesses with operating leases to comply with new lease accounting standards that were issued a little more than a year ago by the Financial Accounting Standards Board (FASB). While the deadlines for public and private companies to implement the new rules is at least a year away, significant time and efforts will be required for most businesses to come into full compliance.

At the core of the new lease accounting standard is the way in which businesses account for and record on their balance sheets all assets and liabilities related to operating leases with terms greater than 12 months. Specifically, lessees will be required to disclose details concerning operating-lease transactions, including information about variable lease payments and options to renew and terminate leases. In addition, lessees will be permitted to make accounting-policy elections to exclude recognition of assets and liabilities relating to leases with terms of 12 months or less.

Under the current lease rules, businesses do not need to include operating leases on their balance sheets. Rather, they must reference these obligations only as footnotes on financial statements. As a result, businesses’ financial statements often exclude the true value of the entities financial performance, including their assets, credit risk and operating efficiency. Under the new rules, a business’ financial statements will materially reflect all lease transactions and will significantly change the way a business reports to stakeholders its performance, including its cash flow, net income and earnings before interest, tax, depreciation and amortization (EBITDA). Businesses will record a right-of-use asset and the corresponding lease liability on their balance sheets, measured at the present value of the lease payments. Additionally, they will record amortization of the right-of-use asset on their income statements, generally on a straight-line basis over the lease term.

Adapting to the new lease standard will be a time-intensive and perhaps arduous process that will require businesses to track down information about existing leases, project the potential impact they will have on financial reporting in the future, and establish new policies, procedures and systems to monitor lease transactions going forward. Complicating compliance to these new rules is a sea of additional new accounting standards that businesses must implement in the next few years, including, but not limited to, those related to recognizing revenue from contracts with customers, testing for goodwill impairment, measuring credit losses, and classifying cash receipts and cash payments. To ease this heavy burden, businesses must prioritize their efforts and consider the following tips specifically tailored to begin transitioning to the new lease accounting standard.

Six Ways to Prepare for Lease Accounting Rule

  1. Assemble a Team to Develop a Plan. Rather than diving into the new lease standards head first, businesses should take time to understand what is involved and how the new reporting rules will affect them. One of the best ways to do this is to establish a project management team that includes external and internal accounting and legal professionals, as well as key corporate managers, including those from IT, real estate, transportation and other business units. The ultimate goals of this team approach would be to develop a project transition plan, budget and timeline for implementation, tracking progress and taking steps to address any and all stumbling blocks that may occur along the way.
  2. Assess the Current Lease Environment and its Impact on Future Lease Reporting. Substantial time and effort may be required for businesses to identify all of their existing leases and the detailed terms and conditions and rights and responsibilities of those agreements. For example, the new standard for lease reporting will require businesses to recognize assets and liabilities for all leases with terms of 12 months or longer; shorter-term leases may avoid reporting requirements if the lessee does not expect to buy the asset(s) in the future. In addition, businesses will have the potentially complicated task of differentiating between reportable operating leases and service contracts, which they are not compelled to recognize on financial statements. In many situations, a business may uncover that an existing contract for real estate, equipment or other property meets the new definition of a lease and must be reflected in its financial reporting under the new guidance or it may recognize that the existing systems it uses to track leases will not suffice in the future. With these discoveries, a business may decide to renegotiate existing leases or forgo leasing altogether in favor of buying assets in the future, or it may decide to invest in a new system for tracking and monitoring leases in the future.
  3. Assess How the New Lease Standard Will Affect How the Business Communicates its Financial Performance.  Because the new standard will represent the first time that many businesses will recognize operating leases on their balance sheets, the amount of lease assets and liabilities, cash flow and balance sheet ratios they report may be different than in prior years. This may present an equally significant difference in how businesses communicate their financial positions and operating efficiencies to investors, lenders and other stakeholders. For example, businesses with large portfolios of leases for office equipment, machinery, airplanes or portfolios of real estate may subsequently report increased amounts of debt owed on their lease obligations. Businesses should consider developing a plan that details how they will communicate these changes to lenders and other stakeholders in advance of the implementation deadline in order to avoid surprises and any adverse reactions.
  4. Invest in New Systems, Technology and Training to Record and Report Lease Arrangements.  Due to the expanded disclosure requirements of the FASB’s new leasing standard, businesses will need more robust systems for capturing and reporting the details of their current and future lease contracts. This is especially true for business that have large portfolios of lease assets, for which software and other technology platforms may be the most efficient option for automating these processes in the future. For some businesses, this may be accomplished by simply working with vendors to update existing software; for others, it may require significant investment in new technology and training.
  5. Update Policies, Procedures and Internal Controls. Under the new lease reporting standard, businesses will need to differentiate between capital or finance leases and operating leases and report the expenses, cash flow and impact of both types of leases on companies’ assets, liabilities and shareholder equity. This could be a daunting task for businesses with large portfolios of lease assets. Not only will they need to develop new policies for classifying leases, they would also need to establish internal controls for monitoring, updating and analyzing lease data in a timely manner.
  6. Prepare for Comparative Reporting.  The new lease accounting standards require a modified retrospective transition, for which businesses will need to apply the new guidance at the beginning of the comparative year. During the first year of compliance, businesses must provide comparative reporting on financial statements to reflect those operating leases that they previously did not account for on their balance sheets. With this retrospective reporting requirement, businesses will likely present on their financial statements significantly different assets, liabilities, income, cash flow and creditworthiness than in prior years.

Preparing for the new lease accounting rules is a monumental task that will require businesses of all sizes and in all industries to expend significant amounts of time, resources and dollars in advance of the December 15, 2018, deadline for public companies, and December 15, 2019, for privately held entities.  By engaging experienced and knowledgeable auditors and accountants in the process, businesses may ease their compliance burdens and come away with new opportunities for improving their internal controls and long-term financial performance.

About the Author: Whitney K. Schiffer, CPA, is a director in the Audit and Attest Services practice of Berkowitz Pollack Brant, where she works with hospitals, health care providers, HMOs and third-party administrators, as well as real estate businesses. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.

 

 

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