NEW LEASE ACCOUNTING STANDARDS...LEASE ACCOUNTING STANDARDS MARKET READINESS SURVEY Page# 2 EXECUTIVE SUMMARY InMarchof2016,wesurveyed#over#150#treasury,finance,accounting,and#tax#

NEW LEASE ACCOUNTING STANDARDS

MARKET READINESS SURVEY

May 2016

An original research study conducted by For use by

LEASE ACCOUNTING STANDARDSMARKET READINESS SURVEY

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EXECUTIVE SUMMARY

In March of 2016, we surveyed over 150 treasury, finance, accounting, and tax professionals about their state of readiness to support the new lease accounting standards and the overall maturity of their equipment leasing programs. The survey asked only 10 questions and was administered by an independent survey firm.

There were five key learnings from the study:

1. Most respondents are in the early stages of preparation with 85% indicating they were reading, studying and getting ready to implement the new standards. Less than 10% of respondents believed they had the right systems in place to comply today.

2. Of those surveyed, 42% were expecting the implementation of the new standards to be “pretty painful” or “extremely painful.” Another 3% stated the implementation would be more painful than a root canal.

3. Equipment leasing lacks a clear owner at most companies. Procurement owns equipment leasing at 46% of companies. But 31% of those with large leasing programs had no designated owner.

4. Most companies do not have an up-to-date inventory of their leases. Of companies with mid-sized leasing portfolios, 65% stated it would take weeks to determine how many equipment leases they have. And 64% of companies with large leasing portfolios stated it could take months.

5. Most companies do not have a system of record in place for equipment leases. Almost 65% were using spreadsheets or “a little of everything” to track these assets.


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BACKGROUND ON THE NEW STANDARDS

In the first quarter of 2016, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) published a new set of standards for lease accounting. Under development for over 10 years, these new standards change the way that public and private companies must account for leases in their quarterly and annual financial statements.

Many of the leases that companies hold for real estate, aircraft, vehicles, forklifts, office furniture, computers and data center equipment has previously been off-balance sheet. Under the current standard, ASC 840 and IAS 17, these off-balance sheet “operating leases” were disclosed in the footnotes of their public filings but will now be reported on corporate balance sheets under the new standard, ASC 842 and IFRS 16. The IASB estimates that $2.2 Trillion of assets and liabilities will transfer onto corporate balance sheets over the next few years. Income statement reporting is impacted as well. PWC estimates that the average company will see a 13% increase in EBITDA as a result of the new standard.

Implementation deadlines vary depending on the fiscal year end and type of firm. Public companies with a fiscal year ending December 31st must transition to the new standards by 2019. For SEC reporting purposes, companies must provide three years of income statements comparables, with an initial date of application of January 1st, 2017.

Implementing these new standards for large companies with complex real estate and equipment leasing portfolios will be no small feat. Accounting organizations will need to create an inventory of all buildings, land, vehicles, machinery, computers and other assets under lease. They will need to review the contract terms for each lease, separating out “non-lease” line-items from leases and service agreements. They will also need to perform judgments and calculations to classify and account for each lease properly, considering fixed and variable rents, end-of-term options and renewal plans.

The goal of this research study is to assess how prepared companies are for the new lease accounting standards.


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0% 10% 20% 30% 40% 50%

End of "Casual Fridays"

Reduced capital expenditures

Reduced cash flow

Delayed equipment acquisitions

Higher TCO

If you had to stop or drastically curtail your leasing activities, what potential effects might be in play? <Click all that apply>

IMPACT OF LEASING TO THE BUSINESS

First, we wanted to understand how important leasing is to the business. A few of the largest and most innovative Fortune 500 companies have discontinued equipment leasing in the past several years because they couldn’t manage their process and portfolio effectively, resulting in increased risks and losses. The new lease accounting standards could drive some companies to stop leasing due to compliance or administrative concerns. Capitalization of leases will likely increase audit scrutiny.

What is at stake if a leasing program fails an audit following the new standards? What would happen if they stopped leasing? What would be the impacts to cash flow and capital expenditures? Would equipment acquisitions be delayed? Would they end up experiencing a higher total cost of ownership for equipment?


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The largest number of companies expressed concerns about higher TCO for equipment. Why might the TCO be higher with leasing? With leasing, companies can return equipment after several years and refresh with a newer model. When equipment is purchased it is typically held and used for a longer period of time. The cost to maintain vehicles as well as manufacturing, IT, office equipment increases the older it gets.

Delayed equipment acquisition was the second highest area of concern if equipment leasing programs were to end. Leasing equipment enables departmental budget holders to stretch payments over multiple years, magnifying their near-term budget options. The approval process for capital expenditures requiring upfront cash outlays are often slower. Furthermore, some companies establish lease-lines with financing companies that can be drawn down over a period of several years. These pre-established lines of credit simplify transactions and accelerate the budget approval process for capital expenditures internally.

Cash flow was also a concern by a high percentage of the respondents. Companies tend to think of cash flow in two ways when it comes to equipment leasing. At a macro, strategic level, CFOs and Treasurers think of Free Cash Flow (FCF), which is calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company generates after investing in its asset base. At a micro level, budget holders think of the difference between the monthly lease payment amount and the upfront cash outlay. If the allocation process is in place, FCF is the monthly depreciation amount had they purchased the assets. In this case, “cash flow” really refers to the monthly reduction in budget commitment benefit that accrues to the budget holder from leasing rather than buying the equipment.

Without leasing, a company may be forced to use its working capital to make up-front capital expenditures to purchase depreciating assets: trucks, computers, forklifts, etc. With equipment leasing, more working capital is available to invest in appreciating assets: sales and marketing expansion, acquiring companies, market investments, or R&D. Treasurers also like the predictability of lease payments. Monthly expenses are known in advance allowing treasury organizations to better forecast and plan for cash needs.

Fortunately, only a small minority of respondents believed that an end to the leasing program might also impact employee perks like casual Friday.


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Next, we asked the survey population to evaluate their own state of readiness for the survey. At the time of the survey, less than 30 days had passed since the new FASB standard was published. And less than 60 days had passed since the new IFRS lease accounting standard was introduced. That being said, the new lease accounting standard had been under development for over 10 years. Two exposure drafts were published, each with an extensive period of public comment. As a result, we were curious whether awareness and readiness for this standard might be higher than other accounting changes. However, only 8% of respondents confidently stated that they know everything they need to know and have systems in place to comply.

0% 10% 20% 30% 40% 50% 60%

Ready

Preparing

Exploring

Not started

How well prepared would you say your organization is to comply with the new lease accounting standards?

Not Started = There’s a new lease accounting standard?Exploring = We’re just beginning to come up to speedPreparing = We are currently studying the changes and will be implementing systems imminentlyReady Today = We know everything we need to know and have systems in place

SELF-EVALUATION OF READINESS


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Not surprisingly, the majority of respondents were either exploring (just beginning to come up to speed) or preparing (currently studying the changes and implementing systems imminently). Less than 1% selected the response indicating confusion -“There’s a new lease accounting standard?”

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Root Canal Surgery

Extremely Painful

Pretty Painful

Slightly Painful

Not Painful

On the following scale, please rate the anticipated challenge that your firm will likely face from the new lease accounting rules.

We also wanted to understand the level of effort expected to be required to implement and comply with the new lease accounting standards. Given that most companies are in the early stages of evaluating and preparing their implementation plan, we decided it would be premature to inquire about the costs of implementation or the expected man-days for the project. Instead, we used a grade instead of a metric in the form of a “pain scale”.


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The majority of respondents are expecting the new lease accounting standards to be either “slightly painful” or “pretty painful.” Only 13% of respondents predicted that the transition would not be painful, an expression of their confidence that the systems, processes and controls required will be in place by the deadlines.

Only 12% expected the implementation to be extremely painful. About a quarter of those compared the endeavor to root canal surgery.

Another way to measure the state of readiness for the new lease accounting standards is to inquire about the maturity of processes, controls, systems and organizational structures.

First, we asked about which group within the organization owns responsibility for the equipment leasing process and portfolio. Whose job is it to measure the economic performance of the leasing program? Whose job is on the line if the portfolio does not achieve the desired financial returns? In our experience, speaking with hundreds of Fortune 500 companies over the past 10 years we have found most companies do not have a clear organizational owner.

• Accounting is involved to validate and approve invoices. Accounting also prepares the footnotes disclosures required for quarterly and annual reports. However, accounting generally lacks visibility into the location, day-to-day use of the equipment (moves, adds, changes), or end-of-term disposition.

• Procurement is involved to select the make and model of equipment to be used for cash purchases. Procurement is also involved in negotiating the lease terms and generating the necessary purchase orders. However, procurement often loses visibility to the equipment once the PO is approved.

STATE OF READINESS – ORGANIZATIONAL STRUCTURE


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Who in your organization is responsible for the success of your equipment leasing program?

0% 10% 20% 30% 40% 50%

Treasury

Accounting

Not Sure

Procurement

• Treasury is involved to support leasing along with other debt, equity and funding strategies for the business. Treasury typically helps with individual deals, comparing lease versus buy options using appropriate discount rates and relative cost of capital. In some cases, treasury vets the counter-parties, given their capital markets relationship. But most treasury organizations have neither the staff or mandate to manage the day operational aspects of equipment leasing.

• Equipment Owners (aka budget holders) are responsible for the day-to-day use of the assets, including a variety of players -- from fleet managers and logistics professionals to office managers and IT organizations. These owners are not candidates to own the leasing program because each of these groups are only responsible for the equipment in their budget. It doesn’t make sense for a warehouse manager to track the leased servers in a data center.


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0%

5%

10%

15%

20%

25%

30%

35%

Less than $10M $10M-‐$50M $51M-‐$200M More than $200M

Who in your organization is responsible for the success of your equipment leasing program?

”Not Sure” Who Owns the Equipment Leasing Program

Not surprisingly, there was not one consistent owner for equipment leasing identified amongst the survey population. The Procurement organization was listed by 46% of respondents as being the primary owner, although only finance and accounting professionals were invited to participate in the survey. Accounting (16%) and Treasury (15%) were also listed by a number of companies.

At almost one quarter of all respondents, the owner for the equipment leasing program was unclear. In our experience, the lack of clarity typically means that no one really owns the program. It is orphaned. There was also a distinct correlation between the size of the equipment leasing portfolio and the lack of ownership. For example, 40% of respondents with equipment leasing portfolios of $200M or more in value had no clear owner (see below).


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To assess the state of readiness we also wanted to understand the maturity of processes and controls for equipment leasing. Where is the state-of-the-art? For example, we asked each company how long it would take them to determine the number of equipment leases they have in their portfolio. The existence of basic lease tracking procedures and systems are a good barometer of process maturity in equipment leasing.

The average Fortune 500 company has over 1,000 equipment leases covering tens of thousands of assets. Each year thousands of pieces of equipment come off lease at end of term. Some are purchased at the end of the lease. Other equipment is returned. And other equipment stays on lease through a renewal.

Additionally, thousands of new leased assets come into the organization each year. During the 36, 48 or 60 month term of a lease, equipment might be moved from one location to another, significantly complicating tracking and accounting. Some might be stolen, lost or damaged causing them to be bought out and moved off the books.

STATE OF READINESS - PROCESS MATURITY

How long would it take you to determine the total number of operating (equipment) leases your company has?

0% 5% 10% 15% 20% 25% 30% 35%

Couple of months

Couple of weeks

Couple of days

Few minutes


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Not surprisingly, more than half of survey respondents stated that it would take weeks or months to determine the exact number of equipment leases. There is a clear correlation between the size of an equipment leasing portfolio and the complexity of tracking the assets. For example, 65% of companies with $50M to $200M equipment leasing portfolios stated it would take them weeks to count their lease population (as compared to 29% of the overall survey group). And 64% of companies with portfolios greater than $200M stated it would take them months (as compared to 23% of the overall survey group).

18% stated that they could calculate their total worldwide equipment lease count in just a few minutes. However, most of these respondents also indicated that they had relatively few leases (less than 250) and smaller portfolios (less than $10M).

0%

10%

20%

30%

40%

50%

60%

70%

Few minutes Couple of days Couple of weeks Couple of months

Companies with $50M to $200M in Equipment Leases



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0%

10%

20%

30%

40%

50%

60%

70%

Few minutes Couple of days Couple of weeks Couple of months

Companies with more than $200M in Equipment Leases


The logical conclusion here is that larger companies have larger portfolios and greater decentralization, leading to greater complexity, fragmented processes, less ownership, and worse data quality. In short, the survey respondents indicated that larger companies have a greater challenge and greater risk in complying with the new lease accounting standard.


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STATE OF READINESS - SYSTEMS

The average Fortune 500 company might have thousands of leases representing tens of thousands of assets across ten or more asset types. And they might have thousands of people authorized to initiate leases located in hundreds of locations around the world.

The sheer volume of equipment leases to be tracked and accounted for suggests that an enterprise level application would simplify compliance with the new standards. However, relatively few equipment leasing applications exist on the market. For this reason, we asked the survey population what technology they are using to track their equipment leases today.

In what format do you store and track your lease records?

0% 10% 20% 30% 40% 50%

Paper

A little of everything

Database-‐driven application

Spreadsheets

Not surprisingly, almost 40% of respondents are using spreadsheets to track and account for their leases. Spreadsheets are inexpensive;; easy-to-use;; and infinitely customizable. However, spreadsheets rarely go through any testing processes and typically lack any version control. For these reasons spreadsheets are often problematic for Sarbanes-Oxley audits. 65% are not using any kind of database-driven software application.


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Almost one-quarter of the respondents indicated they did not have a single system of record for equipment leasing data. These companies are using “a little of everything” to track their leases. In our experience, most companies use spreadsheets along with a combination of yellow sticky notes, file cabinets, email, contract management systems and enterprise applications to track leases. ERP applications, IT Asset Management applications and Real Estate Leasing applications each have capabilities to store some equipment lease data as well. However, none of these applications have either the 100+ attributes, technology features, or sophisticated calculations required needed to comply with the new standard.

More than one third (35%) stated that they use a database-driven application to track and manage equipment leases. For those companies using a database-driven application, we asked how many applications were being used to store the data and how many different organizations were managing the data. Almost 40% of companies are storing equipment leasing data in multiple databases that are managed by many different departments or locations. But another 20% were not able to provide this level of detail -- indicating that there is no real enterprise strategy for managing leasing data.

0%

10%

20%

30%

40%

50%

60%

70%

Less than $10M $10M to $50M $50M to $200M Greater than $200M

Multiple Databases Don't Know

Which of the following best describes the records for your equipment leasing program?

””Multiple Database and Departments or Don’t Know”By Size of Leasing Portfolio


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RECOMMENDATIONS

1. Sense of Urgency - Companies should get started now. Although the first implementation deadlines are not until 2019, companies will be required to provide three years of income statement and two years of balance sheet comparables (i.e. 2017/2018). A large percentage of the companies surveyed are tracking leases on spreadsheets and could not easily determine the number of leases they have. As a result, we are skeptical that those who wait until the last minute (i.e. 2019 or 2020) will be able to reverse engineer the debits and credits needed for their comparative reporting (back to 2017 or 2018).

2. Consider Enterprise Lease Management Applications - Companies should consider adopting an enterprise lease management application for managing their equipment leases, particularly those with large portfolios in excess of $50M. There are specialized applications that manage the lifecycle of equipment leases as well as broader enterprise lease administration and accounting systems that also handle real estate. The best choice will depend upon the unique needs of each organization. Not only will an enterprise application accelerate compliance efforts for the new lease accounting standards, but it will provide better controls for lease versus-buy-analysis and reduce evergreen fees with better end-of-term management. The key capability required for the new standard is the ability to track changes and generate debits and credits at the asset-level.

3. Assign Ownership - Companies should appoint one, clear owner for their equipment leasing programs. This means a top executive in procurement, accounting, treasury or shared services should be selected by the CFO. This executive should be charged with establishing and managing consistent processes, policies and controls across all categories of leased equipment, geographic regions, and product lines. Additionally, this owner should act as the executive sponsor for adopting systems to automate the equipment leasing lifecycle, including the accounting to comply with the new standards.

Over the past 10 years, we have spoken with hundreds of companies about their equipment leasing programs and the new lease accounting standards. In the process we have developed a viewpoint on the best practices that differentiate leaders from laggards in the area of lease administration and accounting. Based upon the survey findings, our experts recommend that companies consider the following three actions to ensure they meet the deadlines for the new lease accounting standards:


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SURVEY DEMOGRAPHICS

The survey respondents represented a diverse range of equipment leasing scenarios. A little more than half reported fewer than 1000 pieces of equipment under lease. And approximately one third reported leasing more than 1000 pieces of equipment.

0-‐250

More than 1000

251-‐1000

No idea

Approximately how many pieces of equipment does your company lease?

Accounting

Finance

Treasury

Tax

Over 150 professionals from finance, accounting, treasury and tax organizations at Fortune 1000 companies responded to the survey. The survey consisted of 10 multiple choice questions. Each respondent qualified for a $5 Starbucks gift card.


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Over two-thirds of the respondents had an equipment leasing portfolio of less than $50M in value. About one-third had very large portfolios in excess of $200M in value.

Less than $10M

$10M to $50M

Over $200M

$50M to $200M

What is the approximate amount of your annual operating (equipment) lease obligation?

The survey was conducted by a third party, Growth Curve Marketing, a leader in market research and B2B marketing services for fast-growth companies.

www.leaseaccelerator.com


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LEARN MORE - ADDITIONAL RESOURCES

WebinarNavigating the Brave New World of Equipment Lease ManagementJoint Webinar between PWC and LeaseAccelerator

Research StudyWho is Most Impacted by the New Lease Accounting Standards

HandbookFASB ASC 842 Lease Accounting Handbook

ArticleGet Ready for the New Lease Accounting Rules

Documents

NEW LEASE ACCOUNTING STANDARDS...LEASE ACCOUNTING STANDARDS MARKET READINESS SURVEY Page# 2 EXECUTIVE SUMMARY InMarchof2016,wesurveyed#over#150#treasury,finance,accounting,and#tax#