TRIRIGA Insights

Begin to prepare your organization for the new lease accounting standard

The IASB and FASB recently issued the Exposure Draft of the proposed lease accounting standards. As many expected, the Exposure Draft is nearly identical to the initial Discussion Paper issued in March 2009. The new lease accounting standard will require companies to capitalize all leases; placing an enormous strain on the financial statements of most companies. IASB and FASB will accept comments on the proposed standard until mid-December 2010, and plans to release the final standard in the second quarter of 2011. The Effective Date of the new standard may not be known until the final rule is issued, but many expect that 2013 will be the first year that companies must follow the new lease accounting standard when preparing financial statements. Although this date may seem remote, companies should start to prepare now in order to successfully transition to the new standard and reduce the negative impact on their financial statements.

As Bill Bosco, member of the IASB’s International Working Group on Lease Accounting, explained in the recent Learn from the Leaders Webinar entitled “Action plan to prepare for the new lease accounting standard”, preparation for the new lease accounting standard can be broken down into a transition action plan and an ongoing process action plan.

The focus of the transition action plan is to fully understand the proposed changes, collect the necessary data about existing leases, and then prepare necessary accounting entries to book existing leases under the new standard. In general, the transition project would include the following steps:

1.Become familiar with proposed lease accounting standard

2.Create a project team with members from all departments involved (Lease Administration, IT, Accounting, Finance, etc.)

3.Verify that lease administration, accounting, and other software systems meet the requirements of the new rule

4.Implement system enhancements or new systems

5.Extract all pertinent lease information:

• Lease term and rents – timing and amounts
• Renewal option terms and rents
• Contingent rent/percentage rent terms
• Residual guarantee terms
• Purchase options terms (currently not needed for accounting but good to know)
• Service elements in lease

6.Identify internal sources for the following information:

• Intentions regarding renewal and purchase options (Business Management)
• Incremental borrowing rate (Finance/Treasury)
• Sales projections for percentage rents (Business Management)
• CPI for percentage rents (Finance)
• Residual guarantee payments (Business Management)

7.Prepare necessary transition entries to book the leases

In parallel with the transition plan, companies must also plan for ongoing operations after the new lease accounting standard becomes effective. To learn more about the transition action plan and the ongoing action plan, please watch the on-demand presentation by Bill Bosco, “Action plan to prepare for the new lease accounting standard”.

Recently, the National Oceanic and Atmospheric Administration published the annual State of the Climate Report summarizing the key climate indicators of 2009. The report, compiled by 300 scientists from 48 countries, concludes that “global warming is undeniable”. Not only was the past decade the warmest on record, but almost every climate indicator shows that climate change is occurring at a more dramatic pace than was predicted by scientists just a few years ago. Although the United Nation’s International Panel on Climate Change (IPCC) predicted in their 2007 report that climate change would bring increased flooding, heat waves, and glacier melting; the severity of the flooding and heat waves experienced around the world over the last few months has been more intense than most expected.

Increased flooding

This year the United States has experienced widespread flooding from New England to Oklahoma. Intense rain in Northern Iowa caused a dam to fail and Middle Tennessee experienced a “1000 year” flood after receiving 19 inches of rain over a two day period. In Pakistan, intense flooding has killed at least 1,600 people and 20 million have been injured or displaced. Approximately one third of the country’s land mass has been affected by the flood. China has also experienced intense rain and flooding this summer. Floods and landslides have killed more 1,100 people and hundreds more are missing.

Intense heat waves

The New York Times reports that record highs are outpacing records lows by a factor of two to one. This correlates with climatologists’ theory of what should occur during a period of rapid global warming. In Russia, this summer has been the warmest ever recorded with temperature in Moscow topping 100 degrees Fahrenheit for the first time in the city’s long history. Thousands of people have died and drought has reduced Russia’s wheat harvest by over 30%.

Accelerated ice melt

Although not a weather event, per se, the dramatic decrease in arctic and glacial ice cover is perhaps the most alarming evidence that increased carbon emissions are warming the planet. This summer a 100-square-mile mass of ice fell off of the Petermann Glacier in Greenland. Since 1979, approximately 1 million square miles of sea ice, equivalent to the area of Alaska and Texas combined, has disappeared. According to Scientists at the National Snow and Ice Data Center and the National Center for Atmospheric Research, Arctic ice cover is decreasing faster than any of the 18 computer models used by the IPCC had predicted.

What does this mean for your organization?

This is just a sample of the severe weather events that have occurred this year. Globally, the average number of weather-related disasters is three times greater than the average at the beginning of 1980. The recent weather disasters around the world have only reinforced the consensus that global warming is one of the most serious challenges mankind has ever faced. Every country and region will be affected, both directly and indirectly, by the increased frequency and severity of weather events.

All indications are that the extreme weather events experienced this summer will continue to increase in the future. Unless there is a concerted worldwide effort to reduce greenhouse gas emissions, these extreme weather events along with rising sea levels will result in trillions of dollars of damage and millions of lives displaced, injured, or killed. As this reality continues to sink in, investors, customers, and regulators will increase pressure on companies to measure and manage their carbon emissions. Investors will increase their scrutiny of a company’s exposure to climate change risks, and an increasing number of customers will evaluate a company’s environmental stewardship when making purchasing decisions. And, even if the Federal Government fails to enact carbon legislation, individual states will continue to take the lead and implement climate change regulations that will directly and indirectly place a price on carbon and increase the price of energy.

Learn more about TRIRIGA’s environmental sustainability software, TREES, to help your organization prepare for the increased focus on carbon emissions.

As detailed in the new whitepaper by Bob Cook, “The New Lease Accounting Standard and You”, the proposed lease accounting changes will force most companies to significantly change their lease administration processes and systems in order to comply with the new rules. Since the new standard will likely not include a grandfather clause for existing leases, companies must begin to prepare for the changes today.

The additional complexity introduced by the proposed changes, especially for companies with medium to large portfolios of leased properties, will require an advanced lease accounting system to manage existing leases and prepare for the upcoming lease accounting standard. There are a number of capabilities that a lease administration system should have in order to manage leases under the new rules. Here are five of the most important features to look for:

1. OSCRE Lease abstract support:
To prepare for the new lease accounting standard companies must collect critical information for each lease in their portfolio. For many companies, the collection and verification of applicable lease data will require the help of third-party lease abstractors. Support for the OSCRE (Open Standards Consortium for Real Estate) Lease Abstract standard streamlines the exchange of lease information between third-party abstraction firms and the company’s lease administration system.

2. Lease option tracking:
Under the new lease accounting standards, the book value of the lease asset will be the present value of the lease payments over the “most likely” lease term. This “most likely” lease term is determined based on the likelihood any renewal options will be exercised. A lease administration system should include the capability to identify all available lease options including renewals, expansions, early terminations and purchase options. In addition, the lease accounting system should be able to track other lease terms, like contingent rent agreements that will have a material impact on lease valuation under the proposed lease accounting changes.

3. Critical date tracking with alerts:
The lease administration system should have the capability to track important lease dates and alert lease administrators in advance when an action is required. For example, a lease may have an automatic extension clause that extends a lease if the lessee does not formally terminate the lease within a specified timeframe. The lease administration system should send alerts to the appropriate person and then automatically adjust the lease value based on the decision taken (extend vs. terminate). This feature is especially important given the impact that a lease may have on the balance sheet on the new lease goes into effect.

4. Automated audit capabilities:
Due to the increased visibility placed on leases under the new lease standard, automated audit capabilities and compliance with Sarbanes Oxley (SOX) section 404 becomes critical. Under the new lease accounting standard, assumptions regarding the exercise of renewal options and estimates of contingent rents can have a significant impact on the book value of leases. The lease administration system must track changes to data values, actions taken by users and provide explanation for the required change. These assumptions and changes should be easily audited.

5. Integration to financial accounting systems
Increased collaboration between the lease administration function and the financial controller will be important to prepare for the new lease accounting standard. The lease administration system should include integration capability to transfer data to and from financial accounting systems. Initially, lease administrators may need to extract data in order to make or validate assumptions about renewal options or contingent rents. Once the new lease accounting standard has been implemented, the lease administration system can send necessary data to the financial accounting system to accurately account for leases on the financial statements.

Once the exposure draft is released and the specific are better understood, additional capabilities for the lease administration system will likely surface.

To learn more about how to prepare for the new lease accounting standard, please attend the next TRIRIGA Learn From Leaders webinar on Wednesday, August 18 at 10 am Pacific (1 pm Eastern). During this presentation entitled “Action Plan to Prepare for the New Lease Accounting Standard”, Bill Bosco, a member of the International Accounting Standards Board’s (IASB) International Working Group on Lease Accounting, will discuss the actions that companies must take today to prepare for the changes to the lease accounting standard.

Recently, the U.S. Government announced that it will begin asking all 600,000 suppliers to provide greenhouse gas (GHG) data. This program is in support of Executive Order (EO) 13514, signed by President Obama in October or 2009, that calls for Federal agencies to “establish an integrated strategy towards sustainability in the Federal Government and to make reduction of greenhouse gas emissions a priority for federal agencies.” Collecting GHG data from suppliers specifically supports section 13 of the EO. This section focuses on measuring, managing, and reducing the greenhouse gas emissions from the governments vast supply chain.

In accordance with section 13 of the EO, the General Services Administration (GSA) has prepared a recommendation of how the Federal Government should track and use GHG emission data from suppliers. The GSA’s recommendations potentially have a significant effect on which suppliers are chosen to supply the $500 billion in goods and services procured by the government each year.

What is the GSA recommending?

In order to incentivize Federal suppliers to provide GHG data, the GSA has recommended that Federal agencies should be encouraged to use GHG emission data as a “procurement preference” when making purchasing decisions. Suppliers that comply with the request for GHG emission data can reasonably expect some level of preferable treatment from Federal agencies. According to the GSA, “Federal agencies should use suppliers GHG emissions reporting status as an evaluation factor in contract awards.” It is important to note that today and Federal agency has the ability to use supplier GHG emission data as an evaluation factor to award contracts. In addition, the GSA has proposed that suppliers who demonstrate leadership in carbon management should receive public recognition from the Federal government. Finally, the GSA recommends that GHG emissions reporting should eventually be a mandatory requirement for a supplier to simply be considered in procurement decisions.

When will recommendations be implemented?

Using a phased approach, the GSA’s recommendations could start to take effect as early as fiscal year 2011. Initially, suppliers will be asked to voluntarily provide GHG emission data for direct emissions (Scope 1) and emissions from purchased energy (Scope 2). Although Federal agencies will not be required to use GHG data as a factor when selecting suppliers, many will factor the data into the decision making process based on their commitments to reduce indirect emissions under EO 13514.

In the second phase of the program, beginning as early as 2012, suppliers will also be asked to provide data about other indirect emissions (Scope 3). For certain products categories, Federal agencies may be able to use GHG data as an “evaluation factor”; enabling them to select a product with a low carbon footprint over the least costly choice. In this phase, suppliers will be expected to have emission data verified by a third–party.

How will the recommendations affect procurement decisions?

According to the GSA’s recommendations, “The most significant incentive for Federal suppliers to submit GHG inventory data is the desire to remain competitive in the Federal marketplace.” As Federal agencies look for ways to comply with EO 13514, they will inevitably evaluate their supply chains to identify ways to reduce indirect (Scope 3) greenhouse gas emissions. All else being equal, agencies will select goods and services from companies that track and manage carbon emissions.

What should suppliers do to prepare for the recommendations?

The GSA’s recommendations to meet the requirements of EO 13514 are yet another reason why companies must address carbon emissions and energy use today. Companies with low carbon intensity compared to their competitors will have an advantage in procurement decisions. Not only does this apply to the Federal Government, but Wal–Mart and other large companies have begun to track, and make decisions based on, the carbon emissions of its suppliers. Suppliers who fail to account for their carbon emissions will be at a significant disadvantage in the near future.

Even more important than simply tracking emissions, is the fact that efforts to reduce carbon emissions often equate to energy use reduction that saves money and improves general profitability and competitiveness. To optimize this alignment between carbon reduction and energy efficiency, organization must understand what area of the business represents the best opportunity for improvement. For many companies, facilities are a major contributor to GHG emission and represent a huge opportunity to reduce environmental impact and energy use. In order to effectively compete within a procurement system that evaluates carbon emissions in the purchasing process, companies need the ability to measure their carbon emissions and then identify cost–effective opportunities to reduce emissions and energy use.

Last week hurricane Alex slammed into the northeast coast of Mexico; bringing with it winds of over 100 miles per hour. Although Alex ranked as a relatively low intensity Category 2 hurricane, the storm still caused over $1 billion of damage and affected hundreds of thousands of people. Experts predict that this is just the start of an unusually strong hurricane season. The National Oceanic and Atmospheric Administration (NOAA) predicts an “extremely active” season with between 8 to 14 hurricanes. The Tropical Meteorology Project at Colorado State University’s Department of Atmospheric Sciences estimates that there is a 76 percent chance that a hurricane will hit the US coast between June and November of 2010. This probability is more than 20 percent greater than the average hurricane season.

Figure 1: Hurricane Alex.

Given the very real risk of hurricanes, earthquakes and other disasters, organizations must be prepared to deal with the potential damage and business disruption that natural and manmade disasters can cause. Effective disaster recovery and business continuity plans are critical to minimize business downtime and property damage. A major component to these plans is facilities. Real estate and facilities management departments must have access to facility information critical to emergency preparedness and disaster recovery management. According to industry analyst, Mike Bell, a business continuity plan must include the following information related to facilities:

• Robust information on facility capacities, contract obligations, and values
• The location, identity, and roles of essential staff, and an established contingency plan for these personnel in the event of a business disruption
• Contingency plans for mission critical facilities in the event of a catastrophic business disruption
• Facilities disaster recovery processes that align and support enterprise business continuity plans

Unfortunately, many organizations struggle with inflexible and cumbersome legacy systems that have incomplete and inaccurate data, poor integration, and a lack of pre-defined processes.

Integrated Workplace Management Systems streamline emergency management

An Integrated Workplace Management System (IWMS) streamlines the creation and implementation of disaster recovery and business continuity plans. IWMS provides critical insight into mission-critical facilities and delivers the centralized repository of essential facility information, processes, and procedures necessary for an effective emergency response.

To learn more about how IWMS delivers the capabilities to support your organization’s disaster recovery plans, read Integrated Workplace Management System – A critical tool in business continuity and disaster recovery management, a whitepaper authored by leading industry analyst Michael Bell.