Time To Upgrade...

Technology to be critical for effective management of new lease accounting   

Implementation of the proposed new lease accounting standards is predicted to require many companies to upgrade – or even replace their current technology systems.

To comply with the new standards, some 25% of respondents in a recent leasing survey said their companies would need a major upgrade to their information technology systems, while 20% said they would actually acquire a new system.

Among those respondent companies with 1,000 or more leases, some 39% expect the new standards will lead to a major upgrade to their technology systems, while 27% expect to acquire a new system altogether.

Earlier this month (February 2011) Deloitte surveyed some 284 executives in the US on the Financial Accounting Standards Board’s (FASB) proposed changes to lease accounting standards. Some 63% of those canvassed were lessees, 28% lessors and the remainder service providers to the industry.

Expressed concern

Deloitte stressed that; although no one can know for sure, once the standard is finalized there could be a bottleneck of peak demand to support the higher volume of technology implementation and conversion requirements – leading to a rush for technology upgrades.

In addition, many executives expressed concern at the integrity of their current lease data – and also the ability of their information technology providers, to comply with the new requirements.

Roughly 65% of respondents said they were not very confident in the integrity of the lease data that is required to comply with the new accounting standards. Even more striking, almost 80% of respondents said they were not very confident in the capability of their companies’ information technology providers to comply.

Testing of current lease data

Deloitte’s stressed; “Inspecting the integrity of lease data now may help in the overall timeline for implementation. Testing the quality of the lease data regardless of the new standard is likely to be beneficial in any event”.

Only one third of respondents said their lease database information systems had the ability to interface with the general ledger in order to calculate accounting entries and adjustments; although, this was the case with 50% of respondents from companies with the largest lease portfolios.

When it came to the tax consequences of the new lease accounting standard, two thirds of respondents said they did not know what they would be - indicating a strong need for more attention to the tax implications.

“Companies may benefit,” Deloitte said, “by taking steps to understand the impact on deferred taxes in advance of the effective date”.

Reasonably up to date

In general terms, however, the survey revealed that respondents were reasonably up to date with the negotiations taking place. Roughly half of the respondents said they were extremely or very familiar with FASB’s draft revisions to lease accounting standards while about three quarters of respondents at companies with 1,000 or more leases were extremely or very familiar with the draft revisions, compared to 58% of those from companies with 100 to 999 leases and 37% at those from companies with less than 100 leases.

Deloitte stressed: “Since professionals who were not familiar with the draft revisions were less likely to have taken the survey, these survey results may not represent the level of knowledge of the draft revisions among all real estate professionals”.

Significant impacts on ratios

Many respondents from lessees and service providers expected the draft revisions to have major or significant impact on:

• balance sheet (64%);

• financial ratios ( 53%);

• income statement (48%);

Among those with 1,000 or more leases, 81% expected major or significant impacts on the balance sheet, 68% on the income statement, and 69% on financial ratios.

In addition, many respondents expected the new lease accounting standards would have material impacts on the following financial ratios:

• debt to equity (68%);

• return on assets (49%);

• enterprise value/EBITDA (41%);

• interest coverage (40%);

• operating margins (37%);

In addition, some 44% of respondents believed that the impacts on financial ratios from the new standards would affect their company’s existing debt covenants.

Deloitte observed: “This may lead to renegotiation of outstanding debt instruments, which could provide a potential opportunity to exact more concession from lenders or borrowers, depending on the condition. Reviewing debt covenants now may help prepare for these possibilities”.

Impact on funding sources

When asked whether their company’s ability to secure funding would be affected by the impact on their financial ratios of the new lease accounting standard, some 35% or respondents predicted that bankers would adjust the language in the debt covenants.

However, 37% of respondents said they did not know what the impact would be on their company’s ability to secure funding, indicating that many companies may need to examine the implications of the new accounting standard more carefully.

Among those at companies with 1,000 or more leases, half thought the new standards would hinder their operations by requiring them to revise performance metrics that rely on meeting EBITDA or operating margin targets. Currently, companies use straight-line accounting for leases, resulting in level occupancy charges each year. Under the new standard, however, leases will be more expensive in the early years due to interest and less expensive in later years.

Shorter lease terms?

Roughly 40% of respondents thought the new lease standards would lead to more leases with shorter terms. However, only 12% of lessees and service providers expected that their companies would make major or significant reductions in lease terms and renewal options, while 37% expected some reductions. These expectations did not vary significantly by the size of the lease portfolio.

Roughly 25% of respondents expected the new standard would lead to:

• more potential lessees purchasing rather than leasing;

• lower valuations due to higher capitalization rates and discount rates;

• higher interest loan-to-values to finance buildings;

These views of respondents of the likely impacts of the new lease accounting standard were similar across those from companies with small, medium, and large lease portfolios.

Roughly 40% of respondents thought that lease capitalization would increase their companies’ liabilities on the balance sheet by less than 15%, while another 33% anticipated increased liabilities of 15% to 49%.

Time required for implementation

Implementation is expected to take some time, especially for companies with larger lease portfolios. Half the respondents at companies with 1,000 leases or more expected that implementation would take one year or longer.

Roughly 25% of respondents—including more than 40% at companies with 1,000 or more leases— expected the new standards would lead them to make major changes to their lease data gathering procedures.

Three quarters of respondents said their companies would provide training to employees on implementing the new lease accounting standards.

Source: International Lease Finance News