“Are We Sure These Numbers Are Right?”
The irony has not escaped us that on April Fool’s Day 2019, all of the public companies around the world, reporting on a calendar year basis, will be preparing for their first quarterly financial reports under the new Lease Accounting standards (ASC 842 and IFRS 16). The associated impacts to the Balance Sheet (where some companies will be increasing Asset and Liability values by more than 50% of their current level), to Net Income and to Shareholder Equity have been well chronicled over the last few years. What has been less talked about is the challenge of ensuring that the reported numbers are accurate, auditable and on time.
In a number of sessions with companies and accounting firms there have been questions about “what is the penalty for non-compliance?” The answer is the same as filing statements that do not comport with Generally Accepted Accounting Principles or having to issue restatements if a company releases inaccurate financial statements. For some reason, the belief that these new standards are somehow in a different class, more of a reporting nuance then a fundamental change to GAAP, has continued to smolder in the corporate C-suite. Unfortunately, barring some last minute adjustment to the transition date by FASB and IASB, many of these companies are looking down the barrel of 18 months of intense effort to comply with something that other companies have been working on for the last two to three years.
Sometime in the first weeks of April, 2019 the question will be asked by every CFO and CEO before they sign their name, “are these numbers right?” With many companies still working to select and implement new technology, find all of the leases and build the process and controls for managing change, here are a few things to consider to ensure that the answer is “yes”:
- “Have we built an audit trail?” – As a shortcut to getting to the numbers, many companies are integrating data from disparate sources to build the Right of Use (ROU) Asset and Liability values for the Balance Sheet. The new Standards will require an auditable process more so than the operational processes to manage the expense information under the existing Standards. Finding, cataloguing and managing the supporting source documents is the critical first step to building that audit trail.
- “Do we have everything?” – The low hanging fruit for most companies are the property leases across the enterprise. Given the value of that spend, most companies have a reasonable handle on their real estate leases. However, equipment leases and embedded leases are generally less well controlled. For businesses that use 3rd Party service agreements for logistics, technology, supply chain or other areas, the effort to identify and gain agreement with auditors as to the instance and value of embedded leases could be a major effort.
- “Are the calculations correct?” – There are close to 100 different technology providers and approaches to capturing the data, applying the calculations and generating the reports needed to integrate to the financial reporting systems. There is no compliance organization (yet) to guarantee that these systems are 100% aligned with the still changing interpretations of the standard. In particular, the rules for transition accounting, practical expedients and building the two year comparative statements retroactively will need to be vetted with auditors and reconciled by accounting staffs before presentation.
- “What about next quarter?” – One of the lower priorities as companies scramble to meet the transition date is the revamping of the change management process for leasing. Highly decentralized companies have delegated lease signing authority to numerous levels and departments. In a FAS13 world where 98% of all leases were classified as operating, this was not an issue. However, now, when someone makes that decision the day before the end of the quarter, or 10% to 15% of your leases expire in a particular quarter, making sure that all changes are captured and accounted for correctly will be a recurring challenge.
By now almost everyone has recognized that the task ahead is both complex and resource intensive. Be careful of claims of magic technology solutions that automate abstraction, or systems “certified or recommended” by accounting firms. The risks of getting it wrong or delivering late can be severe. An article that tracked the drop in stock value after a restatement due to revenue reporting used a 4% metric. So for a company with a $30B market cap, that would be a $1.2B “penalty” to enterprise value. There is no benchmark for restatement due to changes to Lease Accounting, but it is safe to say that no controller or CFO wants to be the first to find out. And, that is no April fool’s joke.