A wave of significant accounting standard-setting has created heavy compliance burdens that many company finance departments are struggling to handle.
Just 37% of more than 140 companies surveyed by KPMG LLP said they are on the right track in their implementation of the new revenue recognition standard issued by the US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), which takes effect at the beginning of 2018 for public companies.
Meanwhile, new lease accounting requirements have companies attempting a challenging process of locating all their lease agreements and extracting data points from them that haven’t been necessary for accounting in the past.
This is a challenge because more than two-thirds (68%) of companies surveyed by PwC and commercial real estate services and investment firm CBRE have used spreadsheets as their primary system for tracking leases, and 84% currently abstract key terms from their lease agreements manually.
Finally, financial institutions in particular are affected by separate new standards issued by the IASB and FASB that require replacing the current incurred-loss models with expected-loss accounting for financial instruments. It’s one of the most significant rules changes in financial institution accounting in years.
“It’s a lot of work for what oftentimes are lean financial reporting groups to adopt three potentially heavily impactful standards,” said Sheri Wyatt, CPA, partner for capital markets and accounting advisory services at PwC.
The problem starts with revenue recognition, as many companies are behind schedule despite a one-year delay in the effective date that FASB and the IASB announced last year. Seventy-one per cent of the KPMG survey respondents are only at the point where they are assessing the accounting impacts of the standard, and an additional 8% haven’t even begun implementation.
This is a concern because almost half of respondents say they will need systems changes—which could be time-consuming. Thirty-seven per cent will be implementing changes to existing systems, and 13% will be implementing a new software solution for revenue recognition.
Respondents in the KPMG survey who are not on track in their implementation said they have other competing priorities, are constrained by human resources, or are lacking financial resources.
“Number one, they’re trying to run a business,” said Dean Bell, CPA, KPMG LLP’s advisory leasing leader. “And you have the annual reporting period and the quarterly reporting periods. Then you’re talking about the various initiatives around these accounting standards that are out there. Beyond that, you have a significant number of updates to do with technology. So I think that companies and their leaders are probably somewhat overwhelmed right now.”
Here are six tips that experts say can help ease the burden of these multiple implementations:
Focus on first things first. Revenue recognition is the standard whose implementation date is coming up first, and for many companies, it may be the most challenging of the three standards to implement.
“With revenue recognition, companies shouldn’t lose focus on the fact that that’s going to be effective fairly soon,” Wyatt said. “… I do think that companies that have been heavily impacted by revenue recognition may not be moving as quickly with respect to leasing because they’re trying to obviously finalise their revenue recognition approach and adoption of the new standard.”
If revenue recognition is a challenge, companies may want to work on the accounting assessment for that standard first before turning over work on systems design and changes to others in the organisation, said Stephen Thompson, CPA, KPMG LLP’s revenue recognition advisory leader.
“Then a company could pivot their accounting focus to leasing and work through that,” Thompson said. “Would that mean having to do them consecutively rather than at the same time like some companies might desire? Maybe. But that may be the reality of it for some companies.”
Finish your revenue recognition assessment. The majority (71%) of companies in KPMG’s survey are conducting their assessment of accounting impacts.
This is a process that Thompson said should involve finance as well as process-focused and IT-focused personnel so that a company can come to a conclusion collectively on what changes need to be made to systems and processes.
In the next three to six months, Thompson said, companies need to finish that process of collecting the information they need to design the changes they need to their systems and processes. That would give them at least 12 months to design and implement those systems and processes.
Bring tax to the table. Just 29% of companies in the KPMG survey said their tax professionals were at least moderately involved in the assessment stage of their revenue recognition implementation.
Those who are not involving tax may be making a mistake, because the new revenue recognition rules may affect existing tax-compliance processes, taxable income, accounting for income taxes, tax accounting method changes, and other areas of tax, including transfer pricing, according to KPMG.
“For some companies, tax may not be an impact,” Thompson said. “But for companies where there will be a change in the accounting, then tax absolutely should be at the table for obvious reasons.”
Many companies do expect the new lease accounting rules to have a tax impact. Sixty-four per cent of companies in the KPMG survey expect the new leases standard to have at least a moderate impact on tax reporting.
Examine your current lease structure. Seventy per cent of more than 500 executives responsible for lease accounting or lease management have either started implementation of the new standard or plan to start this year, according to the survey by PwC and CBRE.
As companies begin their lease accounting implementation, they need to start developing a project plan, Wyatt said.
“Part of that project plan is understanding what your current lease [environment] is,” Wyatt said. “So do I have one centralised spreadsheet or system, or do I have subsidiaries that may maintain multiple [systems] that I then have to aggregate? What’s the level of data in the system? So I think that’s the initial step.”
Companies generally are not having much trouble identifying contracts and collecting data from their real estate portfolios because real estate usually involves large sums of currency managed under an existing system, Bell said.
But the data being captured for real estate leasing often don’t incorporate the terms or data needed to help account for the leases in the future. And leases for items such as copiers, computers, equipment, and auto fleets often are managed offline in a spreadsheet, Bell said.
“Chances are, there are terms in the lease contract that aren’t being captured in current systems,” Bell said.
As a result, extracting data from lease contracts can be a challenge. Some companies are using technology to assist them in this process in an effort to reduce the number of hours spent by staff.
Be mindful of debt covenants. Because the lease accounting standard will bring new liabilities onto company balance sheets, it has the potential to affect debt covenants that may be based on debt-to-equity ratios.
More than half (54%) of respondents to KPMG’s survey said the standard would result in bankers adjusting debt covenants to allow for the reduction in net-worth ratios. Bell said companies should have a discussion with their bankers as soon as possible about the impact of the standard on the balance sheet.
“Because of the lead time here that FASB has given to companies, they’re going to be able to have a conversation with the creditors to say, ‘Here’s what the impact is going to be based on our modelling. What can we do to make sure our covenants aren’t affected as a result?’ ” Bell said. “And we are seeing some leeway that’s being provided by the creditors as a result.”
Multinationals may have dual solution to credit losses. The expected credit loss standards in IFRS 9, Financial Instruments, and FASB’s recently issued standards are not converged and use different models to measure impairment.
IFRS 9 takes effect for annual periods beginning on or after January 1st 2018; for SEC filers, FASB’s expected credit loss standard will take effect for fiscal years and interim periods within those fiscal years beginning after December 15th 2019.
Multinational banks may wish to expedite their assessment of the FASB standard to take advantage of work they are already doing for the IASB implementation, according to Reza Van Roosmalen, a managing director for KPMG LLP.
“The costs of regulatory compliance have been very high for this whole sector, and where they can find efficiencies and scalability, I would think that’s in the interest of the banks,” he said.
These efficiencies may cause banks to adopt the FASB standard early, but they won’t be able to begin reporting under the standards at the same time. FASB’s early adoption period begins for fiscal years and interim periods beginning after December 15th 2018—nearly a year after the IASB standard is required to be adopted.
—Ken Tysiac (firstname.lastname@example.org) is a CGMA Magazine editorial director.