Confession: I love the new accounting standard for companies to report their costs for leases. Not so much because I applaud what the standard tries to accomplish (although I support that too) but rather, because implementation of the standard demonstrates so many compliance and internal control headaches today.
Hear me out. The new standard — ASC 842, Leases — went into effect at the start of 2019. It requires companies to report the costs of operating and finance leases on the balance sheet, when previously those costs were tucked away in the footnotes. It also requires companies to report a corresponding “right of use asset” on the asset side of the balance sheet, to represent the value you get for those leased items.
The intention of the standard is good, simple, and noble: bring those off-balance sheet costs onto the balance sheet, so investors can get a more accurate sense of the company’s financial position.
The implementation has been arduous, to put it mildly. Firms need to understand how their companies create leasing agreements, track all those leases, determine the costs paid and assets gained, and disclose those numbers in one location. That’s not easy.
Well, how not easy, exactly? And what do lease accounting compliance challenges tell us about financial reporting compliance more broadly?
To get some thoughts on the subject, I chatted with Bruce Pounder, a long-time adviser on technical accounting issues and these days executive director of GAAP Lab. Pounder hit several down notes in our conversation: not enough business capability in corporate accounting departments these days, accounting software not delivering promised functionality, audit firms failing to rise to the task.
You can hear a podcast of our conversation (16 minutes long) at the top of this post. Meanwhile, I have a few further thoughts below.
‘Capability’ Is Mighty Strained
Pounder first said that companies have struggled to implement the lease accounting standard because they lacked “business capability” to get the job done. Translation: too few accounting and internal control people for too much work.
First, accounting departments have always been relatively small business functions at the best of times. Large corporations always strive to consolidate accounting in one office, even for diverse operations with many locations and product lines. Then came the Great Recession, when every company tried to do more with less; followed, eventually, by the healthy economy we have today — where unemployment in the accounting profession is roughly 1.5 percent right now.
Meanwhile, the work required to implement new accounting standards has grown, because the nature of the standards has changed in ways that make compliance much more complex.
For example, the lease accounting standard can straddle numerous functions within the enterprise: legal, real estate, procurement, records management, IT, accounting, and procurement, among others. The standard forces companies to have a better sense of how they obtain leased goods, because the final number reported on the balance sheet is much more prominent than it had been before.
That’s a tough job. Especially if your accounting or internal control teams have been working at minimum staffing levels for years, without much exposure to operating processes like leasing retail space, office equipment, data storage, or other goods.
The result of all this is a shortage of human capital everywhere: among companies, technology vendors, and audit firms. All of them are chasing too few people with the requisite business and accounting acumen to make compliance with the standard a palatable process.
A Long History of Capacity Crunch
As I listened to Pounder talk about the leasing standard, however, I had a feeling of deja vu — because these were all the same headaches companies and their internal control departments faced circa 2004, when Sarbanes-Oxley compliance first reared its ugly head.
That was 15 years ago. Have corporate accounting and compliance departments really not evolved since then?
They have, but not enough, given the compliance challenges facing corporations today. Pounder raised a great point with this comment:
In absolute terms, we are better off. But in relative terms, because accounting standards have gotten harder to implement, we still have a gap between what companies are capable of doing based on the people they have… and what needs to happen for companies to be in full compliance with these standards.
We’ve seen that time and again over the last 15 years. SOX compliance put companies through the wringer in the mid-2000s. Then came the financial crisis and Great Recession. Then starting in the mid-2010s we saw a series of major new accounting standards that have thrown one haymaker after another at accounting and internal control teams.
First was the new revenue recognition standard, which went into effect at the start of 2018. Now it’s the leasing standard, going into effect this year. The big challenge for 2020 was supposed to be a new standard for reporting credit losses — but discontent among smaller filers had been so pronounced that the Financial Accounting Standards Board recently proposed stalling implementation for smaller filers until 2023. (Large filers are still looking at a deadline of Dec. 15, 2019.)
Overall, FASB has been rewriting accounting rules to make them based more on broad principles, where companies must exercise better judgment of their own circumstances; to deliver a more comprehensive picture to investors of a company’s financial position.
That’s very different from the financial reporting ecosystem of 20 years ago. It’s been a long, difficult process, still incomplete — and it brings the compliance and audit professions’ challenges with technology and human capital into sharp relief.
One Point About Lease Standard
In our podcast, I did pick on Comcast Corp. and its disclosure of leasing costs and assets. Comcast doesn’t actually report those items in their own lines on the balance sheet. Instead, Comcast rolls them into “Other Non-Current Assets” and “Other Non-Current Liabilities.” Only deep in the footnotes does Comcast identify what those amounts actually are: $4.2 billion in leased assets, $4.8 billion in liabilities.
I asked Pounder: Can Comcast do that?
Technically, yes, he explained. Companies can roll their leasing costs and assets into other line items on the balance sheet, if they still report the specific costs in the footnotes. Which Comcast did, so the company is in compliance.
I don’t love that answer. The point of the leasing standard was to make these costs more transparent to investors — and Comcast does know what those costs are, because it reports them in the footnotes. So why exploit the letter of the standard to dodge listing them on the balance sheet plainly, where retail investors can find them?
Pounder was sympathetic: “I don’t think it counts much for transparency to be some place in the thick of an SEC filing [instead of] the face financial statements themselves.”
Indeed. It’s a shame that large, sophisticated companies like Comcast don’t do better. The spirit of the standard is transparency, and that’s not what Comcast’s disclosures have.