Listen to the latest episode of Bramasol’s Insights to Action Podcast Series. In this episode, Bramasol’s expert John Scott shares insights of ASC 842 that applies to private companies and what implementation issues they are facing.

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Also, below is a transcript of the podcast episode:

Jim Hunt: This is Jim Hunt hosting the next episode of Bramasol’s Insights to Action podcast series. Today we’re going to focus on another aspect of ASC 842 that applies to private companies. A lot of the focus in the past has been on public companies, but in 2020 it’s now becoming private companies turn in the barrel. We’re lucky to have John Scott with us today who has deep understanding of these issues and can really flesh out what private companies need to be doing. John is Senior Technical Accounting Adviser at Bramasol. He’s a proven leader. He’s been with Big Four accounting companies. He’s has CPA audit experience. He’s also been on the client side over the years. He’s successfully integrated new business change projects and he’s built accounting and audit teams. He’s also lived through many compliance projects. So John, thank you for being here today.

John Scott: Thanks so much Jim. I really appreciate it. As Jim mentioned, it’s really important for the private companies this year to tackle ASC 842. As you all know, it was pushed back on the implementation date from January 1st, 2020 now it’s going to be January 1st, 2021 so you’re going to need to implement the standards this year. So, the beginning point for a good standards implementation is the assessment phase. This needs to be a really well thought out, thorough assessment of the types of leases you have, such as operating, finance, etc. You also tackle things about thresholds, your processes, whether you want to go software implementation to handle your leases or just use spreadsheets. You also need to determine whether you’re a lessee and/or a lessor. Understanding the standard is really important so you need to do a thorough reading of it. And finally you need to find out where all your leases are and gather those up.

John Scott: That’s why the assessment is really the key phase in it. It takes more time than you think. Next is something you want to do is tackle completeness. Now what does that mean? That means you use your five-year table, which you’ve always had in your financial statements as a master list to identify that you have all your leases and the easiest way to do that, is take the amount of lease expense from the five-year table and compare that to your lease accounts. If you want to be more thorough, you would also run a query for one quarter with the word “lease” in the query. That way you can capture all leases that may be mis-coded or came through another payment source. That, I would highly recommend. I’ve done a few of these projects and the assessment and the completeness are key issues for the auditors as well as structuring a good implementation project.

John Scott: Next, before you even get the software, you’ve got to figure out what kind of features you need, what kind of lease stuff you need to do. Meaning, are you a lessor? Are you a lessee? Do you have consolidations, joint ventures? There’s a lot of lease software products out there, but you’ve got to find the one that matches up to you. I know SAP has a really good one that could match your needs very well.

Jim Hunt: I assume another question in there kind of revolves around the number of leases as well. Essentially, the scope and scale of your challenge.

John Scott: Absolutely. I mean that’s a good point. I did an implementation that had 3000 leases. There were about half real estate, half machinery and equipment as well as joint ventures, consolidation, etc. So that really can’t be handling with a spreadsheet. It doesn’t take a buildup of a high amount of leases to get out of spreadsheets.

John Scott: Plus you generally want to get out of spreadsheets because it brings up control issues and turnover issues. Who’s got control of the spreadsheets? The auditors have to test those spreadsheets. If you’ve got it in a nice lease software package, it’s already been tested and verified by the auditors and previous audits. It makes it go so much more smoothly. Plus it helps you in your disclosures because in our lease package we have a nice disclosure package that’s in compliance with ASC 842 that automatically generates out of the software and also has supporting documents that you can give to your auditors that really makes the audit process go so much more smoothly so that that is a key point as Jim pointed out.

John Scott: The next thing you need to tackle is, is policy construction. Now what do I mean by that? That means you’ve got to go through and make all these selections that the standard makes you do, such as for capitalization under 842 there is no material criteria for which leases you have to put on the balance sheet. Now what there is in the standard is you can “say” that they’re not material, but to prove that to your auditors, you would need to track those amounts, and I’m talking something de-minimus, such as $5,000 and below. Under IFRS standards they give you that criteria, but keep in mind that GAAP only says “not material”. So you’ve got to track that and figure out what your capitalization criteria is. Along with that, there’s short term leases. Now what does that mean? That means a lease at initiation is 12 months or less in time. Now the criteria lets you select those and doesn’t require you to put those on the balance sheet as well. But obviously you got to track those expenses for both types of leases because they do require footnote disclosure.

Jim Hunt: You can make those materiality decisions within the policy, but you need to show your work when the audit comes around.

John Scott: Absolutely. You got to say, hey, we picked $3000 or $5,000 because we don’t think that’s material and here we tracked all those amounts and you can see the expense for those is not material. So, that’s something you would present to your auditors. Our software as well enables you to track those within the software. Which, makes it much easier to do because you’re still gonna have to track that expense because it is a footnote disclosure under ASC 842. Other factors that you’re supposed to be selecting are in the package of three, which are transition policies where you don’t have to reassess leases, you don’t have to see if it had IDC, or whether an agreement contained the lease. There’s three elements there. Also, you’ll probably want to come up with a renewal policy because the standard says that when you’re more likely than not to renew, you include that term when you’re capitalizing the lease.

John Scott: But having said that, I worked with a company that just said, hey, we’re always going to renew leased equipment. That was their policy. So that made it very easy from a policy standpoint by asset class to know whether or not you will account for that additional lease term in your capitalization calculations. There’s other things and lease components combining those if they’re not material, you know the standard also says that they’re material, you’ve got to separate those, but it makes it easier when you’re able to combine those. Now under private companies, for the discount rate you can use the risk free rate, you know, public companies had to use what’s known as an incremental borrowing rate that doesn’t apply to private companies. So, it’s really important to flush out those policies and have them constructed because that’s going to impact how you handle the capitalization on these leases, especially putting them in the software.

John Scott: Then the next step is what I call the time element. You know overall the assessment phase is going to take you quite a bit of time to do. Also you get into extraction of leases. I mean we used the criteria where we have these 3000 leases. They were taken about four hours per lease to extract. Now do the math on that. That’s quite a bit of time. If you’ve got more complicated pieces, it’s going to take you a long time to read and pull out all the information you need on all the fields to be able to to put those leases in your spreadsheets, which can be uploaded into the software very easily. Also, you’ve got the installation of a software, you’ve got to pick it out and you’ve got to perform the installation. It’s a long project, a few months. Policies and controls will take you a long time to construct.

John Scott: You’ve got to understand your processes, how you do things. That incorporates also into the installation because there is no off the shelf. Every installation of a software is kind of unique to the company circumstance and incorporates those processes that the company uses to handle the accounting for their leases. Also, you’ve got to come up with an edification of how you did the implementation. The auditors want a well thought out, really put together memo that addresses how I did my assessment. How I tested for completeness, what my policies are, what my current processes are, and what my controls are. Also, what’s going to happen at transition. All those things have to be incorporated.

Jim Hunt: Yeah, and just a reminder, as you said at the beginning with regard to time element: the clock is ticking, we’re into 2020 and there’s less than a year to accomplish all of those steps. So it’s not something where you want to be waiting. Do you want to be assessing now how long each step is going to take because inevitably, they tend to take as much time as you planned or more.

John Scott: Absolutely, that’s a good point. I mean the installation I did on a particular big one with the 3000 leases took about nine months. Now having said that, you want to have your whole installation put in place so you can run it simultaneously for at least one quarter. So you’re going to compare what you’re getting out of your software to what your hand calculating. Am I getting what I thought I was going to get? Does it work? Then you can address any kind of bumps in the road. You want to run that at least one quarter, so think about that. Based on all the time that I’ve just told you about, you want to have this done by September.

John Scott: Now here it is January. By the time we start the project it could be February or March. And then also you’ve got to worry about this and we ran into this heavily is the resources. Think of all the private companies are out there doing the implementation right now. There’s just a finite amount of resources to help you do your assessment, get your installation done, do your extraction, and any kind of technical resources you need. So you’ve got to really tackle this. I recommend going at it as soon as possible.

Jim Hunt: A question on that regard and you can hold it for the end if you want, but I’m curious, for instance, for Bramasol and the team that you work on has taken a lot of public companies through the ASC 842 process already. Well, do you have a feel for what percentage of that learning and process knowledge and disciplines maps over to help private companies get a leg up and streamline their implementation process?

John Scott: Absolutely. I mean, think of it this way. For the private companies, after the new standard implementation, there are a lot of comments now from the FCC out there as well as lessons learned by us as we do these installations. We can incorporate those lessons learned, all the comments the FCC made into these new installation for the private companies so they really have some good information which could really streamline and really help you do your, your installation as well as implementation in totality for this standard in a more smooth and orderly fashion. You know what I mean? You can run into other things. I’ll give you a couple of examples on that. Nobody really thought about and said a lot of lot of industries have embedded leases, and it could be a significant amount. You’ve got to go out and grab those, read those agreements and see if you have embedded leases. Now what I mean by an embedded lease is you’re getting in exchange for buying a service, like a free coffee maker , or in healthcare you’re getting a pill dispenser. Those can be kind of significant and add up. I did one implementation where there’s about 2000 embedded leases that we had to analyze. That’s another chunk of time you didn’t even consider. So that’s one thing to keep in mind. Another thing is evergreen leases. What’s that? Well, you’ve been running a storage facility for 20 years on a month to month basis. Well that’s a 20 year lease. That’s just not a month to month. I’m not going to put it on the books. So you’ve got to consider those as well. And those are the kinds of lessons learned as you do the implementation.

John Scott: Another lesson learned is that you don’t underestimate the time it’s going to take you to implement this standard. It’s going to take you a lot longer than you think and there’s a lot of nuances that you didn’t consider and you really have to understand and read the standard and get that technical resource in there to help you implement this project. Another thing to consider is the testing of your installation. That’s really important from an auditor standpoint. Like I said, there’s no off the shelf kind of installation on this. Everything’s got a little bit of customization on it, so you need to test it offline. Do those calculations offline and compare it so what the software has given you to make sure that the software is implemented correctly. That is important to show your auditors as well.

John Scott: Now the final thing I will say is, is what we call analytics disclosure reporting and auditability. What does that mean? Well, regarding analytics, it’s a good thing to get a dashboard. Why not pull additional information out of your leases that you may not need for the standard, and put them into your software, your spreadsheets, so you’re able to do some deeper analytics on your lease portfolio. That’ll enable you to be more cost efficient and tell where your leases are, what you’re paying per square foot, etc. For example, identifying leases by city or by state, maybe you want to shift those leases around to be more efficient. Also, you can tell what you’re paying on a lease per vendor. Maybe you want to bulk purchase leases from certain vendors to get a better deal. That’s what I’m talking about on the analytics that you’re going to be able to extract and you only want to look at these leases one time, so why not grab all that good information, put them in the software or your spreadsheets and you’re able to use that later on in good analytics.

Jim Hunt: Well, I’ll just another note on analytics before we leave it. If you integrate your overall asset management program with your compliance requirements, you really are getting a leg up on your business objectives. You’re managing your assets better and you’re using those analytics. I mean, you might even, not necessarily off the bat, but you were talking about cost per square foot and so on. With integrated analytics tools , you might even be able to bring in utilization, for you know, smart buildings, conference rooms, etc. How often are they used so you can get a feel for how are you using the asset as well as the lease issues and the compliance issues.

John Scott: Absolutely. I mean that’s a real good point you just made. Why not be able to take advantage of this standard and all the hard work you’re putting in to really be able to get some good information to help you manage your portfolio. What I call disclosure reporting. Keep in mind there’s a lot of new disclosures related to this standard. Now we have a software that automatically puts out a disclosure that is in the ASC 842 example format that’s in the standard. It’s a great looking package that you’re able to get and it has all those supporting schedules with it. And keep in mind what you’ve got to disclose is cash flows on the leases. You’ve got to disclose maturity, the five-year table, and you’ve got to disclose weighted average calculations. The software does that for you and it and it produces it in a good format that you’re able to insert right into your financial statements.

John Scott: Then the last thing I’ll say is the auditability. I’ve gone through quite a bit of information, but keep in mind your auditors are going to look at this pretty heavily. So if you’ve done a good assessment, you’ve done a good implementation, you’ve done good documentation, you’ll be able to produce a very good memo that absolutely outlines all the steps you went through to the implementation of the standards and you’re able to prove out through all your supporting documentation that you implemented the standard correctly. You counted for all your leases, your, your disclosures are correct, your policies are in place, you’ve got good controls and processes. So I know I went through a lot of information there, but these are some tips that you’ve got to keep in mind as you go through this implementation project process. And, keep in mind we’re there for you so we would love to help you out with this. We’ve got good software and as I mentioned, we’ve got good technical resources and I wish everybody luck in the implementation of this this year.

Jim Hunt: Not only luck! It’s more than luck that’s going to get this done. That’s for sure. When you’re talking about disclosure reporting and auditability, can you kind of give a high level assessment of how those things, such as disclosure, reporting, audits and so on will be different for private companies versus what we’ve seen with public companies?

John Scott: The disclosures are essentially the same per the standard, but as I mentioned for private companies, your discount rate is different so you’re able to use that risk free rate. It’s become a little bit onerous for these public companies because they have to go out and do the rate calculations for say five year leases, 10 year leases, document it and constantly update the software. That’s not required for private companies. Additionally, you know, private companies might have less leases. Maybe that’s a little bit easier to implement, but all in all you’d want to get out of these spreadsheets and get into a good software because you don’t want to be hand calculating these. It’s ripe for error and it’s not a very good control process and it doesn’t sustain you in the long run. Plus I just mentioned the analytics, you know, good dashboard we’re coming up with that’ll be able to manage your lease portfolio in addition to complying with the standard through the software.

Jim Hunt: Okay. So kind of bottom line then. It sounds like the experience and that teams like your team at Bramasol have had helping public companies over the past few years comply, a great percentage of that maps over and potentially can make it easier for private companies to comply. Although I want to be careful about using that word easy. It’s not something that where they can just sit back, fold hands and say, I’ll deal with it in the second half of the year.

John Scott: Yeah. Not easy, but it’s a great roadmap. As you mentioned. We’re able to take all those lessons learned on all these installations we’ve done at the public companies and transfer it over to the private companies. It’s still time-consuming. Don’t underestimate the time and another point don’t think you can just use internal resources. I’ve seen this a million times because people have full time jobs. The last thing they have the time to do is go ahead and maybe do lease extraction, test assessment, completeness, etc. You really are going to need to supplement those resources from an external source.

Jim Hunt: Right. And along with that, not only do they not have the time to do it, they may not have, it takes a lot of research and understanding to decide what needs to be done. So it’s helpful to have somebody who’s been down the road already and has that understanding.

John Scott: Absolutely. Somebody who really understands the standard, as you mentioned, and has also been through quite a few of these installations and implementations of ASC 842.

Jim Hunt: Well, John, thank you. This has been great. This is a great overview and I know that CFOs and other leaders in private companies are going to get a lot out of this. We’ve made them aware it has to be done, and I think you’ve given them a great overview of the key issues that need to be addressed in order to succeed. So I look forward to our next session together.

John Scott: Yeah, absolutely. Thank you so much.

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