Update May 2013: Since the publication of this article in December 2010, there have been significant delays to the re-drafting of the Lease Accounting Standards ED1. The Re-Exposure Draft was finally published in May 2013 and, as expected, that it still contains significant changes for both Lessees and Lessors, including many of the issues discussed in this article.
Will IT ease the pain of IASB change? asks Nic Evans.
Debate has raged on both sides of the Atlantic throughout the leasing conference season about the International Accounting Standards Board (IASB) proposals for lease accounting. The exposure draft (ED/2010/09) was the subject of a public meeting in London on 5 November, hosted by the FLA and the UK Accounting Standards Board.
Whatever happens as a result of responses to ED/2010/09, significant change is certain. “Lessee capitalisation… is set in stone,” IASB member Pat Finnegan says. “The financial crisis has really dictated that accounting standard setters take a very serious look at current accounting models and not proceed on the glacial path that they have been following for many years.”
How should the industry manage such change?
Be prepared
Nick Pattenden, MD of specialist finance pricing supplier Field Solutions, says: “The thing to do now is to get back to the IASB and say, ‘This will be the effect on my business and this will be the cost’. Do the benefits of the proposals outweigh the costs to us and to our customers?”
Having submitted comments to their national Accounting Standards Board, companies should start to plan. “Time spent planning is never wasted. If you plan for the worst, it won’t be wasted if things don’t turn out so bad. You will need system resources and adequately trained people,” Pattenden says.
A lot of preparatory work can be started now.
“Finance companies will need to review the impact to the business from A to Z and then assess the impact to their systems,” says Ian Charik, Cassiopae asset finance director.
Implementation can be scheduled as soon as the timescale for the new standard is published. Management should avoid other systems-related work, such as mergers and acquisitions, during this time.
Impact on sales behaviour
The complexity of lessee capitalisation may put off many potential customers from leasing. Equipment funders are already hearing from large lessees they will stop leasing for non-core assets.
At the London meeting, Mark Venus, BNP Paribas accounting and reporting and chair of LeaseEurope accounting committee, said: “A purchasing manager whose job today is to rent photocopiers will need to be trained in law and accountancy to be able to analyse the contracts for each photocopier, and to provide estimates back to head office of likely outcomes for each lease.”
Funders may, as part of the sales process, need to provide additional information and illustrations, with independent verification, to help lessees. Treasurers and CFOs may need training about the benefits of leasing.
ED/2010/09 fails to distinguish between lessees’ core assets and fungible assets, like copiers and cars. “In these areas we will see a move toward managed services, and even to contract rentals where, rather than lease specific vehicles, users are provided with the service of a car averaging, say, 18 months old,” Pattenden says.
As the new standards change the timing of funders’ profits from the lease, will this change methods of pricing?
Pattenden claims that in smaller ticket deals sales will still be driven by money over rate of return. “Sales people won’t keep in mind accounting profit. But there will be a less direct connection where business development will target sales of particular products,” he adds.
David Maxwell, director of Classic Technology, says: “While the accounting standards shouldn’t be driving commercial decisions, funders are going to want to see year on year profits. And while the IASB have tried to do away with structuring, this will continue – just in new areas. For bank regulated funders and where there are any tax benefits the pricing will also change.”
Tipping point
ED/2010/09 has a clear impact on lessors’ administration and accounting systems.
FLA chair of asset finance George Lynn says: “To demonstrate the level of complexity we reckon that there are at least 75 steps that you have to go through to get the information that is required for the new methods. To put that in context, there are 10 steps required for a current operating lease, and about 30 steps for a finance lease.”
Cassiopae’s Charik adds: “A lot of systems, on both sides of the pond, have the accounting treatment hard wired – even to the extent that lists of products can’t be changed.”
Joe Franco of IDS sees a similar impact in the US. He says: “The impact of the changes was clearly demonstrated at our recent ELFA National Conference: attendance at the sessions discussing the lease accounting changes was high. And you are also right that most of the systems are hard wired.”
CHP Consulting senior manager Nick Pattison says: “A significant number of companies will have to look long and hard at their systems. This will be the tipping point for a number of lessors, particularly those who have keeping in-house systems going over the years. It will be a significant investment to make the changes needed to in-house systems.”
Lessors who already have modern, highly configurable, systems will have a significant advantage.
“Any changes that do have to be made to our software will have a lot less impact,” Pattison says. “It will be keyhole surgery rather than an open-heart operation. This will save significant time on implementation and re-testing.
Charik says: “Any software changes that are needed will be provided under our support agreements at no additional cost to our customers. We give the guarantee of compliance in each country where our software is operating.”
Pattison believes that making the software changes is not the expensive part, and that the bigger project will be to apply the new lease classifications across the current portfolio. “Performance obligation, derecognition or they may no longer be classified as leases, but rather installment purchase or service contracts,” he says. “There are a number of areas where discretional decisions have to be made. A big ticket lessor can look at each lease but the smaller ticket business will need to apply rules based on contract data. CHP’s ALFA has the business rules engine to automate the decision and it stores contract information at the most detailed level, enabling it to be used as the basis for the classification.”
Multi-GAAP
White Clarke Group chairman Ed White says: “CALMS has been designed to have multiple accounting methods, so you can see the impact of the new methods alongside the old operating and finance leases. A rules-based system allows you to incorporate processes to make consistent judgments needed for the new standards. It will be a lot more work for lessors without this, which will significantly add to their costs.”
Charik says: “Multi-GAAP allows parallel running, with the old treatment running alongside the new methods. Cassiopae allows multiple strings, but systems with just one set of books, or even dual accounting, will struggle.”
Pattison says: “In countries where the take up of the new methods are different you can keep local GAAP, while also using IAS when the parent chooses to adopt it.”
Even companies using compliant packages will face problems if they are running on older versions of software. They may be tied to a particular version of software because of customisations, or they may have held off upgrading because of the effort and cost involved.
Interfaces will give further challenges. The feed of information on new business coming from customer relationship management and point of sales systems will need to be modified. An interface inevitably involves changes to two systems, so this can considerably add to the complexity and timescales for change. Although a lease administration system may be fully configurable for new financial products, the front end systems will be more constrained. Few accountants like to entrust lease classification to their sales force.
Lessors and major lessees will at an early stage need to model the impact of the accounting treatment on their current portfolios of leases.
Pattenden says: “A lot of people will look to Excel to do this job, but this is fraught with problems. We have software that will manage portfolios, but it’s not just a case of plugging it into your database. Data acquisition is the difficult part. No two package software installations are the same. It is a consulting exercise so everyone understands how the data is being used and the assumptions that are made.”
While transitional arrangements for moving to the new standard are still to be agreed, CHP claims its ALFA has another advantage. “We can make mid-life changes to lease income without the need to terminate or rebook the lease,” says Pattison. “This also has an effective date which allows us to make the changes retrospectively, or just going forward.”
What will be the consequences for leasing companies and their customers if the deadlines are not met?
Pattenden says: “Failure to meet the deadlines would be disastrous. It’s a regulatory issue that you can account for your full business, current and future.”
ED/2010/09 – call to action |
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An edited version of this article appeared in December 2010 Edition of Leasing Life.
A printer friendly PDF version of this article can be downloaded from https://www.box.net/shared/vk9s3b5gjl