Accounting for leases under new rules…it’s complicated

In the upcoming fiscal year, financial reporting standards for federal lease accounting will see a significant shift—one that many agencies have been proactively preparing for, and one that will undoubtedly continue to demand coordination and communication far beyond the accounting and reporting teams alone.

The Federal Accounting Standards Advisory Board (FASAB) issued new standards to recognize federal lease activities in 2018. Titled, “Statement of Federal Financial Accounting Standards (SFFAS) 54: Leases,” the standards will result in a large influx of federal operating lease transactions reported on agency balance sheets once they go into effect on Oct. 1, 2023, the first day of FY 2024.

For leases that meet the standards’ scope requirements, the days of off balance-sheet accounting for operating leases are gone. Under the new standard, the lessees will recognize a lease liability and a lease asset at the start of the lease term, while federal lessors will recognize a lease receivable and unearned revenue for both capital and operating leases.

A lot has happened in the five years since the FASAB issued the standards. Originally set to take effect on October 1, 2020, the implementation date was delayed as standard setters issued clarifying guidance, agencies launched implementation plans and the world managed a global pandemic.

Concurrently, the commercial sector implemented new lease accounting standards in 2019 while state and local governments did the same in 2022. In the heat of all this change, alongside other factors complicating readiness, many—if not most—federal agencies are not fully prepared to implement the new standards. Why is that? Well, it’s complicated.

Where the complications lie

SFFAS 54 and related amendments aim to provide transparent and meaningful information regarding leasing activities for federal financial reporting. As simple as this may sound, there are many moving parts, costs and constraints that lend to a complex implementation of the new standards for reporting entities.

Top management challenges affecting implementation of SFFAS 54:

• Federal reporting entities are much larger in scale than commercial entities, and operate within a more complicated regulatory environment with the FASAB, the Department of Treasury, and the Office of Management and Budget—and sometimes other entities—all periodically releasing unique and unsynchronized guidance. (SFFAS 54 transforms proprietary accounting requirements, but budgetary accounting remains unchanged under OMB Circular No. A-11, Appendix B, Budgetary Treatment of Lease-Purchases and Leases of Capital Assets.)
• Leasing transactions are thorny by nature, with many accounting events requiring careful attention (e.g., determining which leases meet SFFAS 54 scope criteria, finding embedded leases, creating amortization schedules, incorporating amendments, differentiating fixed versus variable payments, etc.)
• Identifying a full lease population may prove challenging due to inadequate documentation of existing leases, missing data points and weak internal controls—which may also impact an agency’s audit opinion in some cases
• Many entities rely on error-prone manual processes
• Robotic Process Automation (RPA) is limited due to the lack of uniformity of lease contracts worldwide Incorporating the new standards into processes can demand expensive process and system enhancements
• Agency leadership isn’t always committed when lease accounting isn’t mission-critical
• The implementation of this standard requires collaboration across the organization and involves many stakeholders—magnified by the entity’s size, degree of record centralization, international complexities and number of operating locations

Three factors for a smooth implementation

While there is time before the standard takes effect, it is not too soon to prepare. The actions below can yield a smoother implementation:

Strategic planning and analysis

While state and local governments can implement new standards fairly easily, doing the same thing in the federal space with hundreds of federal agencies and nearly two million employees introduces a vast number of complexities.

Before executing on implementation plans for SFFAS 54, familiarize your organization with the new requirements, encourage wide-scale participation and consider leveraging technology as part of the strategy with relevant financial management solutions.

It’s important to assess required resources and relevant costs along the way. Analytic capabilities can enhance an organizations effectiveness both in the planning phase and post-implementation. For example, data analytics can help with gathering a complete lease population, determining an organization’s lease exposure, and identifying lease transactions.

Many transactions occur following lease inception, including payment activity, principal and interest calculations, depreciation and lease modifications. Gathering this information is particularly challenging if legacy processes and systems have documentation gaps and control weaknesses.

Agencies must also consider the impacts of significant changes on the internal control environment. Emerging risks need appropriate risk responses in the form of updated business processes, information systems and internal controls to prevent or correct errors. Failure to do so could result in audit implications.

Process and system enhancement

SFFAS 54 implementation touches on several business cycles including budget formulation to execution, procure to pay, record to report and acquire to retire. For an end-to-end solution, agencies may need to revisit several systems to ensure they use appropriate data points and interface effectively. As standard setters refine accounting guidance, consider whether interim solutions using a combination of manual procedures and automated functionality might be necessary until fully automated systems are released.

Organizational Change Management

Any significant change to processes or systems is bound to cause anxiety in the workforce, which can lead to low morale and resistance to the new processes. It is possible that some impacted parties likely are not completely aware of what is ahead of them.

Understanding where existing stakeholder sentiment stands now will help drive the types of change management activities that leaders need to put in place to mitigate any potential barriers for success. An implementation cannot be successful without effective agency-wide personnel training to create awareness of new requirements and engage employees on the path forward.

To learn more about our business consulting services, including financial management consulting, visit our website.