Federal lease accounting standard: Challenges for federal agencies

The standard will help improve accountability and reporting of federal agencies’ property, plant, and equipment liabilities and costs by revising the financial reporting standards for lease accounting under generally accepted accounting principles, as defined by paragraphs five through eight of Statement of Federal Financial Accounting Standards (SFFAS) 34, The Hierarchy of Generally Accepted Accounting Principles, including the Application of Standards issued by the Financial Accounting Standards Advisory Board.

In summary, the new standard requires that federal agency lessees recognize a lease liability and a lease asset at the commencement of the lease term unless it meets the scope exclusions or the definition/criteria of a non-intragovernmental short-term lease, contract, or agreement that transfers ownership or intragovernmental lease. A federal agency lessor would recognize a lease receivable and unearned revenue unless it meets any of the scope exclusions or the definition/criteria of a non-intragovernmental short-term lease, contract, or agreement that transfers ownership or intragovernmental lease, according to the new standard.

SFFAS 54 paragraph 2 defines a lease as “a contract or agreement whereby the right to control the use of the property, plant, and equipment is conveyed to another entity for a period of time as specified in the contract or agreement in exchange for consideration.” Beyond common types of leases, like a building, a lease under SFFAS 54 can be an easement, water and power rights, diversion rights, rights-of-way, or cell phone tower or antenna placement agreements.

To date, FASAB has reported that many federal agencies have encountered significant challenges preparing for the successful implementation of SFFAS 54. Some challenges federal agencies are encountering so far include the following:

Challenge: Information System

Some federal agencies have decentralized or antiquated information systems. The information system’s functionality already presents challenges meeting federal agency’s current financial management needs, such as limited system functionality and layers of feeder/subsidiary systems. Federal agencies may need to capture over 100 data elements – such as the lease term, lease incentives, and lease discounts – to properly analyze SFFAS 54. The magnitude of the change will require updates to federal agencies’ existing information systems, or agencies may need to replace their existing information system. Internal resources are often stretched thin as they are usually dedicated to other critical IT projects, including current and future upgrades to enterprise resource planning (ERP) software. Federal agencies have expressed concern about the investment in resources and time to implement a new information system to comply with SFFAS 54.

As a stopgap, some federal agencies might use Excel spreadsheets to track the universe of its leases and calculate the lease liability until they have the requisite and compliant new information system. The use of Excel spreadsheets does increase the risk of error over the input and the calculation of the lease liability as well as inconsistencies with how the data is maintained and managed over time. Without the right system in place, manual processes may become onerous as the sheer volume of data continues to grow. Given the magnitude of the change, federal agencies should update their information system to comply with the new standards. For any stopgap measures implemented, federal agencies should perform risk assessments to identify any risks of material misstatements and ensure internal controls are implemented to address the risks.

Challenge: Completeness and accuracy of the universe of leases

Identifying a complete and accurate population of leases will be a significant challenge for many federal agencies. Federal agencies’ information systems may limit the ability to generate a complete and accurate population. Federal agencies that are decentralized may have additional challenges generating complete and accurate populations as all locations may not have a consistent way to identify and record leases in their information systems. Lastly, if the information system captures federal agencies’ leases, the underlying contract may also be located in several different locations throughout. This will increase the time and effort for federal agencies to obtain and review the underlying contract or agreement. In order to identify a complete population, federal agencies will need to update their information system as well as update their processes and internal control controls.

Challenge: Embedded leases

Leases under scope for SFFAS 54 could be buried within seemingly non-lease transactions such as product or service arrangements, transportation, or contracts granting exclusive use of equipment. Some agencies may have to invest significant time and resources to analyze complex lease agreements, and pinpoint embedded leases, as these agreements are more difficult to identify. Identifying embedded leases such as these will require federal agencies to have tailored processes to determine if a contract or agreement has an embedded lease. Additionally, federal agencies may need to change how these contracts or agreements are recorded in their information system so that these contracts and agreements are included in management’s analysis.

Challenge: Project management

Some federal agencies have not developed a detailed project plan factoring in the necessary actions that will need to occur to implement SFFAS 54 by fiscal year 2024. Without strong project management, federal agencies will likely find it difficult to successfully implement the standard. If the agency implements a new information system or modifies its existing system, will management accurately reflect the amount of time it takes to properly select the new system, implement the system, and train its users? Management should have strong project plans in place to detail the necessary actions required to implement the standard, as well as account for the resources and time that will be required.

Organizational change management

Federal agencies should create working groups with key stakeholders such as contracting officers, property managers, the Office of Chief Financial Officer (OCFO), and their accounting and reporting teams. Strong working groups and support throughout the organization are key to the successful implementation of the standard. Transitioning to the new lease accounting standard will require a significant effort by the accounting and reporting team, who are likely already stretched thin with special projects in addition to the requirements of their daily roles. As federal agencies reorganize and prepare for this undertaking, they should make sure they have the right experience and training to be successful with the implementation. The potential magnitude of the accounting impact of the new standard will necessitate federal agencies to implement a controlled process, policies and procedures, training, and communications for lease management, administration, and accounting that is integrated into the organization’s overall financial reporting processes and internal control structure.

Internal control environment

Management should re-evaluate its control environment over lease accounting to determine what modifications to its internal controls need to occur before the implementation of the standard. Management will have to invest significant time training and communicating to their personnel to understand the standard as well as updating its processes, policies and procedures, and internal controls. Additionally, management should:

• Consider revising how leases are initiated, recorded, and reported in the financial statements
• Re-evaluate and update its internal controls when lease agreements are modified to help ensure the modification is analyzed to determine if there is a financial statement effect under SFFAS 54
• Evaluate how users are identifying leases and reviewing complex lease agreements
• Verifying the accuracy of how key data elements from the lease agreement are recorded in their information system.

Users of the information systems must be properly trained and be able to enter key data completely as well as extract the information accurately from the information system.

Monitoring evolving guidance

Federal agencies should monitor for new guidance from FASAB, the Office of Management and Budget, and the Department of Treasury. Since SFFAS 54 was issued in April 2018, FASAB issued SFFAS 60; Omnibus Amendments 2023, Lease-Related Topics I, SFFAS 61; Omnibus Amendments 2023, Lease-Related Topics II; and Technical Release 20 – Implementation Guidance for Leases. The new standards provided additional guidance for items such as the treatment of purchase options and defaults, discounting the lease liabilities and receivables, and intragovernmental sale-leasebacks. FASAB is currently proposing to delay the implementation of leases that contain embedded leases. It is possible that there will be changes to the guidance from OMB as well as the U.S. Department of Treasury before Sept. 30, 2023.

Preparing for your annual financial statement audit

Federal agencies should begin having discussions now with their external auditors as they prepare to implement SFFAS 54. Proactive discussions about management’s approach to analyzing the population, judgments used, system modifications, etc., will help prevent potential problems and delays after implementation occurs. External auditors will likely request populations of leases to perform independent testing, and having upfront discussions with them will save both management and the external auditor time. If management waits to have these discussions until FY 2024, there is a risk that management changes to processes, policies and procedures, internal controls, and system-generated reports could adversely impact a successful implementation as well as the annual financial statement audit.

During implementation, federal agencies should consider how they are documenting key decisions and judgments, as the external auditor will likely request this information during the audit. If an agency has complex leases, but the leases fall below the capitalization scope or are immaterial, is management documenting their analysis and conclusions? Has management documented how they determine if it will be probable that management will exercise a renewal option? A thoughtful and proactive approach to these types of considerations will greatly enhance and improve the overall audit process.

With the initial effective date only a few months away, it’s imperative for federal agencies to start the process of determining their leases and processes now in an effort to lessen larger issues later.