How has COVID-19 impacted the road to compliance and the accounting industry? Visual Lease’s Joe Fitzgerald discusses why FASB has proposed new changes to its lease guidelines and what it means for companies on their compliance journey.
COVID-19 has shifted the landscape in nearly every industry, and the lease accounting and compliance sectors have been no exception. The Financial Accounting Standards Board (FASB) has recognized the struggles companies have been facing during the pandemic and has proactively proposed changes to its processes and requirements for lessees and lessors in light of these circumstances. The accommodations made include FASB shifting the deadline to achieve compliance, granting private companies more time to prepare to meet its major lease accounting standards, including ASC 842, and several recently proposed modifications to the lease accounting guidelines.
The accommodations FASB made this year demonstrate that the future of many businesses is not as certain as it once was, and the industry is taking note and is willing to adjust. New lease accounting changes might still arise as the economic climate continues to shift, but compliance remains critical due to the time-consuming nature of the work required to gather, analyze and report data to achieve it. Although the road to compliance is a major task, the financial opportunities businesses can unlock in return are immense.
Proposed Lease Accounting Changes and What They Mean
Within the recently proposed changes, released in late October, the first modification applies to lessors and amends lease classification requirements for leases in which the payments are predominantly variable, by requiring lessors to classify and account for those leases as operating leases. With this proposed change, the risk of lessors accruing losses at the creation of leases for sales-type agreements that are expected to be profitable would be mitigated, and the resulting financial reporting would better represent the economics underlying the lease.
The second modification would provide lessees the option to remeasure lease liabilities for changes in a reference index or a rate affecting future lease payments at the date that those changes take effect. This modification would be available as an entity-wide accounting policy election, and – while not overly impactful – it would simplify the process for companies who dual-report for FASB and IASB.
A proposed change that has not yet been seen in the industry exists in the third adjustment, Modifications Reducing the Scope of a Lease Contract. This proposed FASB guideline change defines a lease modification as a change in the scope of a lease, or the consideration for a lease that was not part of the original terms and conditions of the contract. Considerations under this term would include adding or terminating the right to use one or more underlying assets or extending or reducing the contractual lease term.
The modification would ease accounting processes for terminations of one asset within a contract, including a master lease agreement. Due to the economic impacts of the COVID-19 outbreak, this issue has the potential to increase in frequency for companies, especially if lessees continue to consider partial terminations, impairments and abandonments. If passed, the proposed change would alter the requirements if there is an early termination of some leases scoped in a contract that does not financially impact the remaining leases in that contract for both lessees and lessors. In those situations, parties would be exempt from applying modification accounting to the leases that are left, so there is ultimately no change to the accounting for them. This can extend beyond master lease agreements and could apply to any lease arrangement with multiple components, even if they weren’t originally identified.
An example of this is a tenant who enters into an agreement to lease several floors in an office building, where initially, it may not have been important for them to identify each floor as a separate lease item. If they decide to modify the agreement to reduce the number of floors being leased from the lessor, the changes proposed by the exposure draft (ED) may be applicable regardless of whether the entity originally identified each floor as a separate component in the original lease.
The Road to Compliance Remains; Companies Need to Forge Ahead
Next year will be an important year for the industry, because while it may seem like an uncertain time, the accounting industry does not anticipate that the ASC 842 compliance deadline will shift again. Lease reporting at the end of 2020 may bring some additional proposed changes from FASB next year, but it will not affect the overall goals of companies to move forward on their journey to achieve compliance.
To ensure success, cross-functional coordination is key for private companies and government entities to achieve compliance with FASB lease accounting guidelines ahead of the deadline, but due to the time-consuming nature of this process, this is no easy feat. Many organizations fail to recognize how heavy of a lift it will actually be. Gathering, reviewing and reporting all lease data can be an unwieldy process — especially if manual systems, like Excel, are being used instead of a centralized lease data repository.
A centralized system is ideal for companies to efficiently manage leases, because these solutions assemble, track and analyze a company’s lease portfolio all in one place. These systems can also unlock latent financial opportunities in the lease portfolio, enabling businesses to save time and money down the road by recognizing potential overpayments, missed reimbursements or mistakes in tax reporting. Given the uncertain financial situations that some companies may face as a result of the pandemic, finding these often-overlooked financial details and opportunities for savings has never been more important.
With all of the changes that have shifted the landscape this year, the accounting industry has proven that it is flexible and able to adapt its compliance standards to accommodate companies that are dealing with the challenges brought on by the pandemic. With the newly proposed changes, companies impacted by COVID-19 will have new options that will impact their financial reporting to accommodate assets they may have reassessed during 2020. As FASB continues to consider the current climate, companies should get themselves into a position where they can meet the deadline now before it’s too late and need to scramble to get on track.