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Corporate Governance: Preparing for the New Lease Accounting Standard: A Tool for Audit Committees

Highlights

The new lease accounting standard, Accounting Standards Update (ASU) 2016-02, Leases (ASC 842), begins to take effect in January 2019. In an environment already laden with significant new accounting guidance and disclosure requirements, a tool recently issued by the Center for Audit Quality (CAQ) aims to assist audit committees in their understanding of the new standard and provide specific considerations to ensure a successful and timely implementation.

Background

In April 2018, the CAQ released a new tool, Preparing for the New Leases Accounting Standard – A Tool For Audit Committees, as a resource for audit committees in their oversight of the implementation of ASU 842, a standard that fundamentally changes the accounting for leases. The implementation of the new standard will require significant time and resources, affect multiple functional areas, and comes shortly after the effective date of the new revenue recognition standard. ASU 842 is effective for periods beginning after December 15, 2018 for public entities and for periods beginning after December 15, 2019 for nonpublic entities. Early application is permitted.

The CAQ tool is organized into four sections:

• Understanding the New Leases Standard –  this section provides a brief overview  of the core principles of the standard.
• Evaluating the Company’s Impact Assessment – this section assists audit committees in discussing with management and auditors (where appropriate) the impact the new standard will have on the company.
• Evaluating the Implementation Project Plan – this section assists audit committees in their efforts to understand and evaluate management’s implementation project plan.
• Other Implementation Considerations – this section assists audit committees with other considerations, such as transition methods and new disclosure requirements.

The new leases standard is expected to have a significant impact on many companies, so management, with board oversight, needs to communicate transparently with shareholders and other stakeholders as to how the implementation of the new leasing standard impacts the financial statements. Audit committees, of both public and private entities, should ensure not only that the accounting has been done properly, but also that new disclosures being provided are understandable. Equally important is the consideration of the internal controls that support the accounting and reporting for the new standard.

Key Considerations from Each Section of the CAQ Tool

Understanding the New Leases Standard

ASC 842 fundamentally changes the accounting for leases by requiring a lessee to recognize on the balance sheet a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The new standard also includes less significant changes to lessor accounting. Audit committees need to understand these changes together with the expectation that certain systems, processes, and controls will likely need to be timely updated to correspond with the new standard.

Evaluating the Company’s Impact Assessment

When evaluating the company’s impact assessment, audit committees may want to ask a number of detailed questions aimed at understanding how the impact assessment was performed, who was consulted within the scope of the assessment, what factors were considered, what other considerations (e.g. debt covenants, income tax effects, regulatory compliance, etc.) exist, when pro-forma/draft financials will be presented to the audit committee, and details of the view of the company’s external auditor on the impact assessment.

Evaluating the Implementation Project Plan

Due to the breadth and complexity of the new standard, companies should develop an implementation project plan and communicate it to the audit committee. Audit committee questions to management and auditors regarding implementation should be reached in the following key areas:

• Timing and scope of the implementation project plan,
• Adequacy of the culture (e.g., tone at the top) and resources to support the plan,
• Involvement of key stakeholders,
• Changes to accounting policies and significant accounting judgements required,
• Changes to systems necessary to account and track leases under the new standard,
• Changes to controls governing the adoption and reporting under the new standard.

Other Implementation Considerations

Audit committees will want to understand management’s transition method. As of May 2018, and upon transition under ASC 842, companies are required to adopt a modified retrospective method that results in a restatement of prior years presented. At the March 7, 2018 meeting, the Financial Accounting Standards Board (FASB), tentatively decided to affirm a proposed additional and optional transition method that would permit companies to record a cumulative effect adjustment in the year of adoption. In addition, audit committees will want to understand certain judgements regarding practical expedients. These judgements should be incorporated into the implementation project. Similarly, audit committees will want to ensure that preparers are transparent in the process and results of implementation. They should be able to articulate in relevant disclosures the impact of the new standard implementation (estimated when applicable), all relevant facts, and demonstrate a comprehensive analysis of the different accounting alternatives in arriving at reasonable judgements. Audit committees should keep in mind that additional disclosures are required both before and after adoption. Finally, thought should be given to company-specific considerations, including but not limited to, control-readiness and any statutory reporting requirements.

Next Steps

The CAQ tool serves as a valuable resource to audit committees in the execution of their oversight duties with respect to increasing transparency, consistency, and reliability within the financial reporting chain.

Please contact Centri for more information on how we can assist with preparing your company with the new leasing standard.