Implementation considerations for private companies Staying on track with the new lease accounting standard, ASC 842

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1 Implementation considerations for private companies Staying on track with the new lease accounting standard, ASC 842

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3 Implementation considerations for private companies Staying on track with the new lease accounting standard, ASC 842 Operating in an unprecedented time of change, privately held companies today are challenged to produce results while navigating an increasingly complex marketplace. One such important change relates to lease accounting. In 2016, the Financial Accounting Standards Board (FASB) issued a new lease accounting standard update (ASU ), which with subsequent amendments, are codified in ASC 842. The new standard will take effect in early 2019 for public companies with calendar year ends and a year later for all others. The result of adopting ASC 842 is to bring most operating leases, which are currently accounted for off-balance sheet, onto the balance sheet. In doing so, ASC 842 changes the very definition of a lease. Private company executives should understand what constitutes a lease to appropriately identify the population of contracts that are themselves leases, or contain leases, and make needed changes to their accounting systems. Deloitte has developed a roadmap to help prepare privately held companies for implementation of ASC 842 by better understanding this complicated standard and developing strategies for overcoming unforeseen challenges in the implementation process. Mitigating risks: A phased approach During an online Deloitte poll, almost 27 percent of respondents from privately held companies indicated that they plan to adopt the new leasing standard using the modified retrospective approach, with 20.5 percent planning to take the comparatives approach under ASC 840 practical expedient (see figure 1). It appears companies are relatively split when weighing the methods of adoption. Figure % 26.7% 22.0% 52.7% 2.8% 20.5% 15% 33.6% Modified retrospective (original requirement) Comparatives under ASC 840 option (proposed alternative) Don t know/not applicable Not yet started In the process of identifying the lease population Accounting analysis complete New system fully implemented Don t know/not applicable Some percentage totals may add up to more/less than 100% due to rounding. 1

4 Implementation considerations for private companies Staying on track with the new lease accounting standard, ASC 842 Regardless of the chosen approach, there is no time to waste. When asked how far along their company is with the implementation of the new lease standard, nearly 34 percent of the poll respondents indicated that they are in the process of identifying the lease population, while 22 percent indicated they have yet to start. Given that the new standard is expected to add $2 trillion in lease obligations to S&P 500 balance sheets, companies would likely benefit from prioritizing these efforts and wrapping their figurative arms around the implementation process as quickly as possible. Taking a phased approach (see figure 2) can help organize key activities that should be considered across the ASC 842 implementation life cycle and address the complexities and challenges that are likely to arise during implementation. The sheer number of activities involved makes clear that this effort is likely to take a significant amount of time. Moreover, the process will not end once a long-term lease accounting solution is implemented. Ongoing maintenance is imperative to position a business for effective adherence with the standard over time. Figure 2 Stage 1 Readiness, assessment, and planning Stage 2 Development of transition process and system selection Stage 3 Lease abstraction and data migration Stage 4 Implement long-term lease accounting solution Stage 5 Deployment and ongoing maintenance Key activities Lease landscape/ portfolio assessment Data quality/gap assessment Accounting, tax, and process assessment Roadmap/ work plan development Technology review Interim technology solution Design/develop accounting and reporting under current and future lease standards Pro forma scenario analysis Internal controls and process development Lease abstraction Data migration from existing systems Data sanitization and normalization Consider thirdparty data ownership and involvement Enhancement to the initial data capture process Deploy long-term technology solution for leases Integrate solution with existing lease accounting procedures, as necessary Revisions to internal controls design and development Develop, manage, reconcile, and monitor dual reporting result Lease accounting and businessas-usual process refinements Ongoing refinement of technology solution and steady-state process Technical accounting support Training Ongoing quality control 2

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6 Implementation considerations for private companies Staying on track with the new lease accounting standard, ASC 842 Expecting the unexpected Data management, IT system reconfiguration (and, in some cases, implementation), resources, and adoption time are implementation challenges that have arisen for early adopters of the new standard. Other issues companies could encounter during the implementation process include: Application of judgment and estimation: With ASC 842, almost all leases will be recognized on the balance sheet. As a result, a company s judgments on whether a renewal is reasonably certain, or in determining if service contracts constitute or contain leases, could be crucial. Also, the standard requires companies to make estimates of assets fair value and to determine incremental borrowing rates. Data management: Collecting and abstracting data could be time-consuming and resource-intensive as companies may now need to gather information that is not necessarily contained in lease agreements. Internal controls and business process environment: Companies may need to consider current and additional controls to support significant judgments and post-commencement monitoring as a result of the standard. Debt covenants: The new standard requires companies to present operating lease liabilities outside of traditional debt, which may provide relief to some. Nevertheless, it will be critical for all companies to determine the ASC s potential effects on debt covenants, so discussions with lenders will likely be needed to understand possible implications and determine whether amendments may be required. Income taxes: Potential tax implications are typically situational, so the implementation team will benefit from involving the company s tax department, which could further stretch the organization s resources. Agility is an increasingly important capability in today s business environment. Education and preparation are pivotal activities when facing major legal, regulatory, and standard-setting changes. By putting a roadmap in place that the entire organization can work toward especially when it comes to implementing ASC 842 private companies can set themselves up for effective compliance. Contacts Dharmesh Ajmera Audit & Assurance Partner Deloitte & Touche LLP dhajmera@deloitte.com Joe DiLeo Audit & Assurance Managing Director Deloitte & Touche LLP jodileo@deloitte.com Kirsten Vosen Audit & Assurance Partner Deloitte & Touche LLP kvosen@deloitte.com

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8 This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication. About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee ( DTTL ), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as Deloitte Global ) does not provide services to clients. In the United States, Deloitte refers to one or more of the US member firms of DTTL, their related entities that operate using the Deloitte name in the United States and their respective affiliates. Certain services may not be available to attest clients under the rules and regulations of public accounting. Please see to learn more about our global network of member firms. Copyright 2018 Deloitte Development LLC. All rights reserved.