THE MONTH-END CLOSE PROCESS - …...The latest foreign exchange rates will need to be uploaded into the lease accounting system from the ERP on a periodic basis - at month-end or more

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THE MONTH-END CLOSE PROCESSTHE MONTH-END CLOSE PROCESS

FOR LEASE ACCOUNTING

INTRODUCTIONTo comply with the new lease accounting standards, most organizations have had to implement new business processes, organizational structures, and information systems. While some organizations have transitioned smoothly, others are experiencing significant challenges adapting to the new complexities introduced by the leasing standard. Those with the largest lease portfolios are the ones having the greatest challenges.

Many of these organizations have muscled through the early years of adoption using a combination of brute force, high-priced consultants, and global headquarters staff. However, those approaches will not scale over the long term. Success with lease accounting will require organizations to transition to a highly automated record-to-report process that includes a consistent, repeatable close process that fits into the overall corporate reporting timeline.

[email protected] | www.leaseaccelerator.com | 1-866-446-0980The Month-End Close for Lease Accounting

As compared to the historical close process used under the legacy leasing standards (e.g. ASC 840, IAS 17), a number of new steps have been added to the record-to-report process. There are new disclosures, new GL accounts, and new controls required. But perhaps the most cumbersome new procedures fall on the teams outside accounting. The groups that manage the real estate and equipment leases now need much more robust processes for tracking assets and contract events throughout the lifecycle.

Many of the individuals responsible for performing the close are new to lease accounting standards. Historically, few organizations outside of the real estate and financial services sector have maintained a strong talent base in leasing. Larger companies have hired new staff to close the talent gap. However, most of these newly hired personnel require extensive training. Smaller organizations are relying on general accounting staff to handle leasing. However, lease accounting is typically just one of many different job responsibilities which limits the level of expertise that can be developed at smaller firms.

Historically, accounting for operating leases was primarily performed on a cash basis, with some straight-lining of expenses for larger real estate. Most organizations performed the legacy lease accounting processes on spreadsheets. However, the new standards are too complex to manage on spreadsheets, leading many organizations to implement new, specialized lease accounting applications. The majority of these “new” systems are early in their product lifecycles and lack robust close functionality. As a result, many accounting teams are using system hacks and manual reconciliation processes to arrive at the complete set of monthly journal entries needed for the close.

LEASE ACCOUNTING CHALLENGES

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NEW PROCESSES NEW PEOPLE NEW SYSTEMS

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The close process for lease accounting will vary from company to company. Each organization will have slightly different processes, systems, and controls in place. In some cases, these steps will be performed in a different sequence depending upon a number of factors, such as:• Overall organizational close timeline and external reporting deadlines• Level of centralization of the accounting resources performing leasing activities• Number of general ledger accounts and level of automation to upload journal entries• Materiality of the leasing portfolio relative to other balance sheet assets, liabilities, equity, and other matrices• System used to perform foreign exchange conversions as well as amortization calculations• Frequency and complexity of incremental borrowing rates used• Involvement of cross disciplinary teams such as Treasury, Procurement, Business Units, Tax, Real Estate, and Financial Planning and Analysis

PURPOSE OF THIS GUIDE

In this guide we will outline the most common steps that organizations will need to perform in the lease accounting close:

3The Month-End Close for Lease Accounting

Master Data Updates

Account Maintenance

Event Procedures

GL Upload & Reconciliation

Disclosure Generation

Period End Close

Post-Close Activities

1.

2.

3.

5.

6.

7.

8.

Lease Accounting Close Process

Control Procedures4.

Master DataUpdates

AcccountMaintenance

EventProcedures

Control Procedures

GL Upload &Reconciliation

DisclosureGeneration

Period EndClose

Post-CloseActivities

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THE MONTH-END CLOSE PROCESS

THE MONTH-END CLOSE PROCESSFOR LEASE ACCOUNTING

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1. MASTER DATA UPDATES

LEASE ACCOUNTING APPLICATION

Periodically, the lease accounting system will need to be updated with new master data. Examples might include changes to general ledger codes, cost centers, tax rates, depreciation methods, economic lives, credit ratings, or debt weights. Other examples might include the addition of new physical locations, new asset types, and new lessor relationships. Typically, these master data updates would be performed before account maintenance and event procedures.

The latest foreign exchange rates will need to be uploaded into the lease accounting system from the ERP on a periodic basis - at month-end or more frequently. In addition, periodically apply updates to the incremental borrowing rates used to calculate the assets and liabilities.


• Countries• Asset Categories• Lease Terms• Legal Entities• Central Treasury

Incremental borrowing rates

• Tax Rates• Debt Weights• Credit Ratings• Economic Lives

Financial Variables

• Cost Centers• GL Codes• New Locations• New Leasing Companies

ERP MASTER DATA

• Daily Rates• Weighted Average Rates• Spot Rates

Foreign Exchange Rates


ACCOUNT MAINTENANCEThe general ledger accounts, profit centers, or cost centers associated with different assets might change during any given accounting period. For example, a leased truck that was historically being used by the team responsible for product line A is now exclusively being used by product line B. As a result, the profit center associated with the truck will need to be updated. Account maintenance activities are applicable to both equipment and real estate leases. Suppose that a field sales organization historically occupied two floors of an office space lease that is now being used by customer support. The cost center associated with the lease will need to be updated. Cost center allocations are another area to review. For example, a rack of data center servers that may have been 100% utilized by the financial planning team may now be 50% shared with the sales operations team. If so, the lease expenses need to be split and allocated across the two different accounts.

Location changes are another type of account maintenance procedure. Certain categories of equipment assets can change their primary location during the term of a lease. For example, three forklifts may be relocated from a distribution center in Amarillo, TX to another one in Lubbock, TX during the middle of a lease. In such cases, the participant information associated with the leased asset should be updated.


• Sales• Marketing• Support

• Finance• Operations• Product Dev

REAL ESTATE LEASES

Cost Centerallocations

• Product Line A, B, C• Operating Company A, B, C• Geographic Region A, B, C

Cost Accounting

• Leasing Companies• Geographic Locations• Leased Asset Categories

ParticipantCHANGES

EQUIPMENT LEASES

2.


The account and participant changes listed above may not trigger a modification or remeasurement of the accounting for the lease. Nonetheless, ensuring accuracy is important for internal controls reporting as well as internal cost accounting, budgeting, forecasting, and planning purposes.

For most companies, the greater challenge will not be making the updates to the system, but rather identifying that a change needs to occur. Accounting organizations will need to devise processes to survey the business about the utilization patterns and movements of leased assets. Examples of best practices include:

A lease lifecycle management application can help to track these utilization patterns and movements.

• Periodic end-user attestations – On a monthly, semi-annual, or annual basis, Accounting can request users of the assets confirm the existence, location, utilization, and reasonably certain holding period of leased assets under their supervision.

• Detailed budget reporting – When business managers see line items for leased assets that their departments are no longer using being applied to their cost centers, they often change behavior to start proactively reporting changes to the accounting team. The overall organization benefits as well from the cost savings realized through better data.

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EVENT PROCEDURES On average, 70% of a typical lease portfolio changes during any given year. New leases are signed. Rents change. Contracts are modified. Others expire and are renewed or terminated. Ensuring the completeness and accuracy of the lease portfolio will require strong event procedures at month-end close to perform commencement, termination, and modification accounting.

Staff will need to confirm that all new leases signed during the current period have been captured. These should include not only newly leased assets, but subleases as well. Lease-leaseback and sale-leaseback transactions along with associated gains will need to be identified. Outsourcing contracts and service arrangements should also be reviewed for potential embedded leases.


COMMENCEMENT ACCOUNTING

• New Leases• New Subleases• Sale-Leaseback• Lease-Leaseback

• Contract Modifications• Rent and Payment Changes• Lease Term Changes• Purchase Option Plans

• Terminations• Buyouts• Returns• Deposit Refunds

Commencement Accounting MODIFICATION ACCOUNTING Termination accounting

3.


All leases that were terminated during the current period should be identified as well. These should include not only leases which hit the contract expiration date, but also leases that may have been terminated early. For example, some equipment asset leases may be bought out or returned early due to lack of use, loss, theft, or damages. Real estate properties may be terminated mid-contract as a result of changes to business plans.

Organizations may want to add a step in the close process to notify accounts payable of any recently terminated leases. This additional control will reduce the risk that payments continue to be made for assets that are no longer being used.

Additionally, potential impairment scenarios will need to be identified and the appropriate accounting applied.

Perhaps most challenging will be ensuring that leases which may require a modification or remeasurement have been identified, reviewed, and approved prior to the end of the period. The different lease accounting standards have slight variations, but most include triggering events that could impact term, consideration, and discount rate.

Examples of triggering events include: • Contract modifications• Extensions or reductions of the lease term• Changes to purchase option exercise plans• Residual value guarantee estimates changes• Variable payments transitioning to fixed rents• Changes of estimates• Adding or returning a portion of a leased asset

Accounting organizations will need to establish new controls and business processes to identify these events.

Many organizations will close the leasing subledger several days before the period end. There may be events that occur in the interim period between subledger close and period close that impact the accounting. For example, there may be 1) new leases signed, 2) changes to existing contracts, or 3) lease terminations in the last few days (or weeks) of the month. An additional set of interim event procedures should be implemented to identify these events. The level of sophistication required will vary depending upon the duration of the interim period as well as the materiality of the events.

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TERMINATION ACCOUNTING MODIFICATION ACCOUNTING INTERIM EVENT PROCEDURES

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• Identify Highest Materiality and Inherent Risk• Match to Key Fields on Contracts

CONTROL PROCEDURESDuring the close process, a series of control procedures should be executed to verify the accuracy and completeness of the accounting. The types of controls will vary from organization to organization, but most will design procedures to address the areas of highest inherent risk and those that potentially breach materiality thresholds. Common areas of focus include:• Confirming the accuracy of inputs to and outputs from systems• Validating judgments, estimates, and assumptions used• Reconciliations between the general ledger and the subledger

Organizations should consider controls to confirm the accuracy of the data inputs to the lease accounting system as well as to test the accuracy of the journal entries produced as outputs.


ACCURACY OF SYSTEM INPUTS AND OUTPUTS

4.

Inputs

• Liability Zeroes Out• Asset Fully Depreciated• Expense Equals Accounts Payable• Clearing Balance

OUTputs

Lease Accounting Application

• Entered but Not Booked • Booked but Not Classified • Classified IncorrectlyIncomplete Processing


Checking the data inputs for each individual lease will not be practical for most portfolios. As an alternative, many organizations choose 1) to review only contracts with the highest materiality or 2) to inspect data fields with the highest inherent risk. For example, there may be a process to review all leases above a certain dollar threshold. The key fields from these leases should be matched to the data source to ensure that the inputs were correctly entered into the system. Commencement date is an example of a key field that is often a focus area because it is an important driver of the payment schedule and the lease term used in the accounting.


INPUTS

A third test that many organizations are performing is identifying leases that were not properly processed in the system. For example, some leases may have been entered into the system but never properly booked. Others may have been booked but never properly classified. Still others may be classified but incorrectly. Ideally, the lease accounting system would provide a work queue or report identifying these scenarios.

INCOMPLETE OR INCORRECT PROCESSING

To test the outputs, debits and credits can be exported from the lease accounting system into a spreadsheet then analyzed to confirm results meet expectations. Examples of tests that may be performed include: • The expense equals the accounts payable clearing account balance or cash expended• The right-of-use asset is fully decremented at end of lease• The liability accounts zero out

OUTPUTS


Lease accounting requires a substantial number of judgments, some of which may be appropriate to review during month-end close.

Discount rates, which have a significant impact on the ROU asset and lease liability calculations, are a common focus area for inspection. Strategies to quickly identify potential incorrect discount rates that require further inspection include:• Reviewing all new leases and modifications during a period to verify that they fall within an expected range consistent with current rate tables• Comparing the weighted average discount rates used for the current period to those used in the prior period to identify discrepancies

Organizations that report under US GAAP adopting under ASC 842 may want to focus on classification errors as these can impact both the balance sheet and income statement. A specific set of controls to verify the accuracy of assumptions and calculations used for classification may be appropriate.

For example, verify for all newly classified releases: • The accuracy of fair value assumptions• The validity of judgments about buyout options• The appropriateness of system overrides

VALIDATING JUDGMENTS, ESTIMATES, AND ASSUMPTIONS

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RECONCILIATION

Once the detective control procedures are completed, the final journal entries should be prepared for upload to the general ledger. Organizations will need to weigh the costs and benefits of different approaches ranging from fully automated system-to-system integration to manual file extract and upload through the user interface. Companies with multiple different ERP platforms may need to use several different approaches to ensure the journal entries are posted correctly to the GL.

Upon successful completion of the upload, the general ledger will need to be reconciled with the subledger to identify variances and make corrections. GL reconciliation for lease accounting will be more complex with leasing than for other subledgers. Unlike accounts payable or accounts receivable which roll up into a single GL account, leasing often touches 10-15 different GL accounts.

One common cause of reconciliation errors is posting errors. When the journal entries are uploaded from the leasing subledger to the GL, there might be duplicate posts, failed posts, or incomplete posts that create inconsistencies in account balances. The challenges are most pronounced for organizations with multiple general ledgers for which multiple upload processes are required.

Another common root cause of reconciliation errors is foreign exchange. In the conversions between transactional, functional, and reporting currencies, there may be inconsistencies in the exchange rates applied or the number of decimal places used in the calculations.


GENERAL LEDGER UPLOAD

5.


Large organizations may have intercompany transactions between different entities. One unit’s lease expense is another unit’s income. These internal transfers are important for local statutory reporting. However, they should be eliminated in consolidation for external reporting to avoid double counting.

INTERCOMPANY TRANSACTIONS

Leasing Subledger General Ledger


Right-of-use assets

Reconciliation

Lease Liabilities

P&L Items

Right-of-use assets

Lease Liabilities

P&L Items


DISCLOSURESThe new leasing standards have introduced a number of new qualitative and quantitative disclosures. Ideally, the quantitative reports should be highly automated for items such as: • Maturity analysis of lease liabilities, both undiscounted and discounted• Short-term lease expense• Variable lease expense• Weighted average remaining lease term • Weighted average discount rates

However, some organizations are electing not to track off-balance sheet items such as short-term, low-value, and variable lease expenses in their lease accounting system. As a result, separate processes may be required to generate the appropriate disclosures from source data in the accounts payable system. Additional controls may be required for these journal entries that are not produced directly by the lease accounting system.

Some organizations will have more complex disclosure requirements that require modeling and reporting in a spreadsheet. For example, companies with segment reporting by geography, product line, or business unit may not be able to fully automate the reporting due to the complexity. Others that have statutory reporting that does not align with their fiscal calendar may require customized reporting strategies to comply.

Many of the qualitative disclosures such as assumptions, judgments, policy elections, practical expedients, and general descriptions of the lease population are unlikely to change frequently. However, companies will need to ensure that new contracts and modifications identified during the event procedures (e.g. sale-leasebacks) are included as appropriate.


6.


PERIOD CLOSEOnce all of the accounting and disclosure reporting is completed and the reconciliation with the general ledger is complete, the subledger can be closed. Some organizations may perform a soft close before completing activities such as control testing or disclosure generation. The subledger can be re-opened, if necessary, to make adjustments that are material to the reporting such as journal entries that may have been missed or an “on top” adjustment to correct prior period errors.

Larger organizations with multiple legal entities and general ledgers will use financial consolidation applications to produce the final data presented on the balance sheet, income statement, cash flow statement, and various footnote disclosures. Post-consolidation, the financial statements will need to be produced in formats consumable by end users including Word, Excel, PDF, and XBRL.


7.


The lease accounting system should be able to report on all the new leases and expired contracts from the last few days (or weeks) of the prior period. The unrecorded lease activity can be reviewed to assess the best approach. For example, if the unrecorded activity was material then a “top-side” entry into the general ledger may be appropriate. If it was not material, then an adjusting entry recorded on the first day of the new period may be a better option.

POST-CLOSE ACTIVITIES


Following the close, teams should revisit event procedures to identify any changes to the lease portfolio that were not captured in the prior period accounting. Organizations with a longer duration between the time of subledger cutoff and the overall close will likely have more new leases, contract changes, and terminations to evaluate.

Subledger Close

CorporateGL Close

New LeasesRenewalsBuyouts

Terminations

OUT-OF-PERIOD ADJUSTMENTS

PRE-CLOSE INTERIM PERIOD POST-CLOSE

8.


ADDITIONAL BEST PRACTICES


Although the specific processes and controls needed for the leasing close might be different than for other subledgers, many of the same best practices apply:

• Roles and Responsibilities – Outline the expectations of each of the key organizations involved in the close process. A center of excellence or shared service center may take the leadership role, but will be critically dependent upon their peers in the business units and other parts of the finance organization for success.

• Defining Standard Operating Procedures – Document each of the key processes involved in the close with narratives and flowcharts. User guides for key systems should detail how to perform testing, run reports, and export data. Escalation procedures should be defined for how to troubleshoot and resolve errors.

• Schedule of Activities – Define a close calendar for lease accounting with a list of key completion dates for account maintenance, subledger cutoffs, and reporting deliverables that maps into the overall corporate financial close calendar.

• Contingency Plans – Identify contingency plans for last minute out-of-office scenarios that might arise with key staff members and unplanned system availability issues that arise. Maintaining an accurate registry of the users associated with each leased asset can help to accelerate any last-minute questions that might arise about specific assets.


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THE MONTH-END CLOSE PROCESS - …...The latest foreign exchange rates will need to be uploaded into the lease accounting system from the ERP on a periodic basis - at month-end or more