Appendix D — Implementation Activities
Appendix D — Implementation Activities
D.1 Introduction
In implementing ASU 2016-02 and other related ASUs (collectively referred to as “ASC 842” herein), entities will need to change not only their accounting for and financial reporting of leases but also their related systems and processes. It is important for all entities to develop an implementation plan well before ASC 842’s effective date. Though some of the accounting changes may seem intuitive, the data and systems requirements needed to bring about those changes are significant and, without preparation, may be overwhelming.
Further, because many companies have numerous lease agreements involving multiple decentralized locations and lease data may be maintained in spreadsheets or hard copies, the collection and abstraction of data can be resource-intensive and time-consuming. Although certain elements of a company’s lease data may be in an electronic format, such data may not have been subjected to Sarbanes-Oxley internal control procedures, may reside in disparate systems, and may be insufficient under the requirements in ASC 842. A centralized information repository may be critical to the development of a lease inventory.
The objectives of this appendix are to (1) help entities begin their planning and assessment process related to adopting ASC 842 and (2) provide entities whose adoption might be further along with some ideas to supplement their current implementation approach and ensure that they consider all critical steps in the process. This appendix is divided into the following sections:
- Getting Started (Section D.2) — This section provides readers with helpful tips and some suggested “dos and don’ts” for implementing the guidance in ASC 842.
- Phases of Implementation (Section D.3) — This section summarizes five phases of implementing the guidance in ASC 842, including activities that an entity may consider including in its implementation roadmap and factors governing the approximate length of time that each activity will take to complete.
- Important Decisions (Section D.4) — This section focuses on certain decisions that an entity will need to make to adopt ASC 842.
D.2 Getting Started
The adoption of ASC 842 may be a daunting task, but by developing a detailed and thoughtful implementation plan, entities can break down the transition into multiple stages so that they can work toward achievable goals.
Before charting a course for their transition to ASC 842, entities should consider the following “dos and don’ts”:
- Dos:
- Identify a cross-functional team of professionals from all key decision-making departments at the entity’s organization (e.g., accounting, finance, IT, tax, human resources, real estate, procurement, investor relations, legal, and internal audit) to ensure that all departments are represented before management agrees on a plan on how to adopt ASC 842. In doing so, an entity may need to establish a steering committee, program management team, or both, made up of individuals from various functions and business units. In addition, global or multinational entities should identify key contacts in each international region, especially if business models differ internationally.
- Keep all affected departments abreast of the transition plan. This is especially important given the extensive changes in ASC 842 with respect to the lessee accounting model. Historically, entities may not have involved departments outside of accounting (e.g., IT, tax, human resources, real estate, procurement, investor relations and legal) in decisions related to the implementation of new accounting guidance. An entity could consider developing a periodic communication detailing accomplishments and upcoming activities to keep personnel outside the steering committee and the program management team informed during the implementation period.
- Create a roadmap outlining realistic goals and key milestones for the entity to work toward in making the transition to ASC 842.
- Assess the various solutions available for complying with the requirements in ASC 842 and test the solutions against the entity’s business needs.
- Consider changing how the entity executes and manages leases (e.g., centralized vs. decentralized approach), since the entity may have an opportunity to change those historical practices during the implementation period.
- Leverage knowledge and efficiencies gained from the adoption of other accounting standards.
- Engage with auditors early in the implementation process to obtain concurrence on the entity’s accounting policies and positions under ASC 842.
- Don’ts:
- Do not assume that ASC 842 does not have a significant impact on the entity. Although the guidance focuses on changes to the lessee accounting model, the entity should also analyze the changes to the lessor accounting model.
- Do not underestimate the time and resources needed to appropriately implement ASC 842 and collect the necessary data. Start planning now to ensure that the entity is ready before the effective date.
- Do not include only a small group of accounting personnel on the transition/implementation team.
- Do not make decisions in silos. Specifically, do not (1) make IT design decisions before identifying business and functional requirements or (2) make business decisions without the involvement of IT.
- Do not overlook the new quantitative and qualitative disclosure requirements when identifying the data needs and building the business/functional requirements.
D.3 Phases of Implementation
One of the key ingredients for a successful adoption of ASC 842 is putting together a roadmap for implementation. The sections below highlight five phases of adopting ASC 842, including key activities that an entity may perform when developing such a roadmap as well as factors it may consider to gauge how much time and effort it will take to complete certain steps in the transition to ASC 842.
The activities and timing for each entity’s roadmap will vary depending on (1) the quantity and variability of the entity’s contracts, (2) its existing systems and processes, and (3) the amount of resources dedicated to its transition plan.
As illustrated below, stakeholders throughout the organization will need to be involved in the adoption of ASC 842. Further, while the initial steps of an adoption plan focus on understanding the technical accounting changes, other aspects of the project can occur contemporaneously. As certain technical accounting conclusions are reached, the total lease population can be identified, IT/systems implications can be assessed, and internal training can begin. During the implementation period, an entity’s normal operations do not cease; new leases are entered into and existing leases are modified or terminated. Accordingly, the adoption of ASC 842 should not be viewed as a linear process.
The five phases of adopting ASC 842, as discussed in the next sections, are (1)
assessment, readiness, and planning; (2) development of policies and selection
of a software or IT system solution, if applicable (collectively, “solution”);
(3) lease abstraction and data storage; (4) solution implementation; and (5)
deployment and aftercare. Key activities are associated with each phase of
adoption. Certain of these activities may be performed during multiple phases of
the adoption process, while others may apply to a single phase.
D.3.1 Phase 1: Assessment, Readiness, and Planning
The first phase of the adoption effort should focus on understanding the
accounting and disclosure requirements, understanding an entity’s lease
population, and performing a data gap analysis. The next sections discuss
these activities.
D.3.1.1 Understanding the Accounting and Disclosure Requirements
One of the first steps an entity must take in creating a transition plan is to understand the technical accounting changes and elections offered under ASC 842. Further, it is critical for entities with international operations that will be subject to statutory filing requirements to understand the differences between ASC 842 and IFRS 16 (see Appendix B for a summary of these differences).
Although entities frequently focus on the changes to a lessee’s recognition and
measurement for leases (see Chapter 8), it is also important
for entities to consider implications for lessors (see Chapter 9) and
the new disclosure requirements (see Chapter 15). In addition to
understanding the new disclosure requirements, an entity should
continually monitor the disclosure requirements of SAB Topic 11.M (SAB
74)1 during the implementation period. Furthermore, an entity should
consider the relevant principles and key points of COSO’s2
Internal Control — Integrated Framework, as updated in 2013 (see
Appendix
E). Further, SEC registrants are required to disclose any
material changes in their ICFR in a Form 10-Q or Form 10-K in accordance
with SEC Regulation S-K, Item 308(c). The implementation activities
related to disclosures may be monitored and considered in all phases of
the implementation period.
D.3.1.2 Understanding the Lease Population
As part of the first phase of the adoption process, an entity should determine its complete lease population. The purpose of understanding this information is to allow the entity to identify potential accounting, data, or other operational issues so that it can plan the level of effort it will need to expend to achieve compliance and align resources for the future phases.
To better understand the lease population, an entity could give a lease survey to all relevant personnel or business units. Such a survey should request the number of contracts by class of underlying asset for lessees, lessors, and subleases. It may also be helpful for the survey to contain questions about the existence of certain contract terms and attributes. These may include, but are not limited to, the following:
- Variable lease payments, including variable lease payments with a floor or minimum.
- Renewal, termination, and purchase options.
- Lease incentives.
- Refundable and nonrefundable security deposits.
- Residual value guarantees.
- Initial direct costs.
The survey could also include questions about the frequency and nature of
contract modifications as well as about the average term of the
contracts. If an entity has international operations, it is important to
learn the language of the contracts, if unknown. Finally, it may be
useful to ask a question regarding the existence of contracts with any
service providers that use their own assets to meet their obligations
under the service arrangement (i.e., in the delivery of services to the
entity). Such a question may help the entity begin to identify contracts
that are, or contain, leases and that were not previously accounted for
under ASC 840. Note that, as discussed in the Connecting the Dots in Section 16.5.2.1, entities may not carry
forward any previous “errors” (i.e., incomplete identification of
leases) in making the transition to ASC 842.
In addition to performing a lease survey, it may be necessary for an entity to sample leases for contract review to understand the lease population. It is recommended that contracts from various classes of underlying assets be selected for review. As part of the review, an entity should identify the contract terms and attributes and should corroborate the information gathered in the lease surveys.
D.3.1.3 Performing a Data Gap Analysis
Another key activity during the initial phase of lease implementation is a data gap analysis. In performing this analysis, an entity should reconcile the lease elements in its current system or spreadsheet to all the lease elements it needs to comply with the accounting and disclosure requirements of ASC 842. As part of this reconciliation, it is also recommended that the entity differentiate between gaps that must be filled for existing leases at transition and gaps that should be filled only on a go-forward basis for new leases.
The lease survey and contract review activities described in Section D.3.1.2 may also prove beneficial to
the data gap analysis, since certain lease elements may not be relevant
to an entity’s existing lease population and thus can be eliminated or
deescalated when an entity addresses the data gaps identified at
transition.
The data gap analysis is critical to understanding resource needs and required lead time in the later lease abstraction phase (see Section D.3.3).
D.3.2 Phase 2: Development of Policies and Solution Selection
The second phase of the adoption effort consists of two primary activities: the
development of accounting policies and selection of the long-term solution
(discussed in the next section and Section D.3.2.2). Entities are likely
to commence the activities in phase 3 before the activities in phase 2 are
substantially complete.
D.3.2.1 Development of Policies
The main technical accounting activities that an entity performs in developing accounting policies are (1) holding working sessions to understand lease strategies and practices; (2) understanding the lease population; and (3) documenting accounting policies, including practical expedient elections.
The development of policies is an iterative process. Consequently, there is no set rule on when an entity should perform this task. However, as the entity begins to understand more about its lease strategies and practices, it may be inclined to amend initial decisions. Accordingly, the development of accounting policies should be viewed as an ongoing part of the adoption process (i.e., an entity may perform this task during multiple phases of its adoption efforts).
The working sessions held to understand lease strategies and practices will be the key to determining accounting policies and supporting the ultimate decisions reached. The working sessions may highlight key attributes of certain agreements by underlying class of asset, the business decision for including the contract terms in the agreement, when options (e.g., purchase options or renewal options) are considered and exercised by the entity, and other relevant information. In addition, an entity is likely to hold working sessions with its treasury department regarding the determination of the discount rate, as defined under ASC 842 (see Chapter 7).
After completing these activities, an entity will be able to determine and document its updated accounting policies under ASC 842. These policies may address the following topics:
- Scope and definition of a lease (see Chapters 2 and 3, respectively), including conclusions about embedded leases.
- Lease term, including application of the “reasonably certain” threshold (see Chapter 5).
- Discount rate (see Chapter 7).
- Presentation and disclosures (see Chapters 14 and 15, respectively).
- Differences between U.S. GAAP and IFRS Accounting Standards (see Appendix B).
- Portfolio approach (see Chapter 8).
An entity should also determine which practical expedients it will elect in
adopting ASC 842, including those related to transition relief,
separating lease and nonlease components, short-term leases, and the
discount rate. These decisions are described in further detail in
Section
D.4.1. For assistance in making these decisions, the
entity should leverage the knowledge gained in phase 1 and in the
working sessions described above.
The entity’s tax department should also assess the impact of ASC 842 and document and implement changes to its existing processes. This assessment and these process changes may be completed during or after the other accounting policy development activities. The tax department may consult personnel from the core accounting function to better understand the lease landscape and changes.
In developing these policies, entities should ensure that they (1) dedicate enough time and resources to them and (2) obtain auditor concurrence before finalizing them.
D.3.2.2 Solution Selection
Activities related to solution selection include, but are not limited to, developing business and functional requirements. The purpose of developing business requirements is to (1) present and document the key requirements for any system changes that are needed and (2) identify the data requirements and ledger systems affected by ASC 842. The objective of developing functional requirements is to establish granular accounting calculation rules that an entity’s solution will need to perform, while also considering other business needs. That is, solutions do not need to be limited to compliance and can focus on other business efficiencies, such as lease administration (e.g., processing lease payments) or procurement decisions (e.g., lease vs. buy).
Although the development of business and functional requirements has historically been an IT activity, entities should review these requirements with other business functions, including the core accounting function, corporate real estate, and procurement, to ensure that the requirements are sufficient.
Ultimately, an entity may decide either to (1) enhance its existing IT infrastructure to better comprehend the storage, calculation, and reporting requirements or (2) select a new solution. If an entity is considering a new solution, it should build a vendor scorecard to ensure that all business functions provide feedback and that systems are compared on a similar basis. Often, it takes significant time to contract with the external technology vendor.
D.3.3 Phase 3: Lease Abstraction and Data Storage
The third phase of the adoption effort is centered on data readiness, which
includes activities related to lease abstraction and data storage. This is
often considered to be the most difficult phase of implementing ASC 842.
Many entities have entered into numerous lease agreements at decentralized
locations and have lease data in disparate spreadsheets or hard copies.
Furthermore, lease agreements may not contain required information (e.g.,
the incremental borrowing rate). Consequently, collecting and abstracting
lease data may be time-consuming and resource-intensive. As mentioned
previously, entities are likely to commence the activities in phase 3 before
the activities in phase 2 are substantially complete. The next sections
discuss the activities performed during this phase.
D.3.3.1 Data Validation, Normalization, and Migration
The initial step in addressing data readiness is to validate the data (i.e., ensure that it is accurate). Such data can take many forms and be applied in various ways. For example, one business unit may have updated the lease payment stream for an adjustment to an index, while another business unit may track the adjustment separately.
Upon determining which data will be leveraged in a new solution, an entity must
normalize the data (i.e., organize it in a consistent format to increase
readability and usability) and migrate it (e.g., upload it to the
system).
D.3.3.2 Supplemental or Comprehensive Lease Abstraction
When an entity completes the validation phase for existing data, it should use the results of the data gap analysis to identify which supplemental elements to abstract. For some entities, some or all leases may have to undergo comprehensive abstraction.
As mentioned previously, not all required data elements can be determined from the lease agreement. Furthermore, an entity will often need to use judgment in assessing whether certain data elements are required (e.g., when determining the lease term). Those performing the abstraction should work closely with the core accounting function to understand the appropriate method to use for this process.
The abstracted data may be stored, as applicable, in an offline template, a temporary solution, or the new long-term solution selected, depending on the timing of the other phase activities.
D.3.3.3 Process Change to Initial Data Capture and Data Maintenance
An entity should establish a process for capturing the normalized data, as soon as its format is known, to address the new requirements. For example, for new leases, entities may train personnel to appropriately abstract all relevant data so that the previous data activities described are completed on an ongoing basis. Also, entities should establish a process for identifying modifications or terminations for existing leases for which the previously described activities were not performed. That is, while the validation and abstraction are being completed, an entity’s data should not become stale.
D.3.4 Phase 4: Solution Implementation
The solution that is selected in phase 2, if applicable, will govern the timing and activities in the solution implementation phase, which may include technical integration with an entity’s existing system(s), customized configuration, and validation of functionality. These activities may be conducted (1) in house, (2) with an external vendor, or (3) both. An entity’s IT department is often heavily involved in a solution implementation; however, the core accounting function should also participate.
The solution implementation phase should also include revisions to the design and development of internal controls to address the changes to the lease accounting process for the new solution.
D.3.5 Phase 5: Deployment and Aftercare
Although adopting ASC 842 may seem like a one-time effort, the success of an entity’s adoption of the guidance in ASC 842 depends partly on the activities performed during the deployment and aftercare phase. After adoption, the entity should perform a postimplementation review to ensure that (1) any system modifications or upgrades are functioning as intended, (2) any changed or newly implemented internal controls are operating effectively, (3) the entity’s personnel are following the new accounting policies, and (4) disclosures are comparable to those prepared by others in the same industry or industries. Depending on the outcome of the postimplementation review, some entities may need to continually dedicate resources to ensure compliance with ASC 842.
D.4 Important Decisions
Discussed below are some of the important topics that all entities should consider while making the transition to ASC 842.
D.4.1 Entity Elections and Transition Reliefs
ASC 842 offers explicit practical expedients that can be elected by certain entities or in certain arrangements. These elections include the following:
- Elections by class of underlying asset:
- Short-term leases (see Section 8.2.1).
- Separating lease from nonlease components (see Section 4.3.3).
- Election for lessors for all leases:
- Sales taxes collected from a lessee (see Section 4.4.2.1.2).
- Election for private-company lessees for all leases:
- Discount rate (see Section 7.2.3).
-
Use of the written terms and conditions of a common-control arrangement (see Section 8.3.5.2.1).
- Transition reliefs:
- Use of hindsight (see Section 16.5.1).
- Package of practical expedients (see Section 16.5.2): whether a contract is or contains a lease, lease classification, and initial direct costs.
- Land easement practical expedient (see Section 2.4).
D.4.2 Individual-Contract Versus Portfolio Approach
In addition to making decisions about the expedients explicitly offered in ASC 842, an entity will need to determine whether to apply the guidance in ASC 842 on a contract-by-contract basis to all leases or whether to account for certain types of leases on a portfolio basis (see Section 8.2.2). Although ASC 842 should generally be applied on an individual-contract basis, an entity may apply a “portfolio approach” if it reasonably expects that the impact of such an approach on the financial statements would not be materially different.
The effort an entity needs to expend in gathering information will likely dictate whether it applies the portfolio approach to certain leases. For leases in which all contract terms are nearly the same and data elements can be summarized rather than abstracted from the individual lease contracts, the portfolio approach may be an effective option. That is, a primary benefit of the portfolio approach is to eliminate the cost of individually gathering data for all of the contracts.
D.4.3 Dual Reporting Requirements
An entity is required3 to restate prior periods under the modified retrospective method. That is, an entity will need to run parallel financial reporting systems during the period of transition to capture existing leases under ASC 842 and ASC 840.
An entity may leverage the new processes and systems established to comply with ASC 842 when applying ASC 840 during the dual reporting period. Conversely, an entity may decide not to disrupt the existing process and to apply both the existing and new processes during the dual reporting period. The entity’s resource limitations and system capabilities are key factors for it to consider in determining the best approach to use for dual reporting.
D.4.4 Capitalization Policy Considerations
Entities may want to consider establishing a materiality threshold for
evaluating whether to recognize, on the balance sheet, leases that otherwise
must be recognized under ASC 842. For more information, see Section 2.2.5.2.
Footnotes
1
SEC Staff Accounting Bulletin (SAB) 74 was
codified as SEC SAB Topic 11.M. See Deloitte’s September 22,
2016, Financial Reporting Alert for
further discussion.
2
The Committee of Sponsoring Organizations of the
Treadway Commission.
3
This transition requirement is not applicable if the lessee elects the Comparatives Under 840 Option. For more information, see Sections 16.1 and 17.3.1.4.1.