With the issuance of the new ASC 842 lease accounting standard (ASU 2016-02), most companies are finding their existing ERP or accounting system has not yet been updated to track and calculate the required information. This has created a need to select a niche piece of software to perform the new calculations and generate the required general ledger updates and disclosure reports.
Because all companies have to comply with the new standard by either 2019 or 2020, there is now a type of California Gold Rush for software vendors in the real estate administration and equipment management domains; plus, many CPA and consulting firms have developed lease accounting software solutions to sell.
At Aventine Hill Partners, we have been supporting our clients by assisting with both the technical accounting aspects of adopting ASC 842 and process and technology consulting. We help our clients select the lease accounting software that best fits their company; then, assist in gathering and loading existing leases for Day 1, and implementing procedures for new lease arrangements going forward (Day 2). Based on our experiences so far, I prepared this outline of things that companies will typically consider when buying lease accounting software.
How Many and What Type of Leases Do You Have?
Obviously, the first criteria to know is how many leases you have. More than a thousand lease contracts will lead to selecting certain enterprise scale applications while only having twenty leases leads to selecting a dramatically lower cost tool.
For companies with few leases, there is a temptation to just say the lease calculations can be done in a spreadsheet without buying any software. However, in discussions with our clients, we have found that as few as 10 leases often justifies investing in a low cost piece of software. The reason is because you have a more auditable record of your calculations and will also have a SOC report from the vendor for the software. An error found after the fact in a spreadsheet you developed yourself can be judged to be a material weakness. This is not a fun outcome to manage.
Next, it is important to know how many real estate leases you have versus equipment leases. And, whether some of your equipment leases are master contracts with many assets associated with a single lease. These matter because they lead you to the first strategic decision.
Do You Want to Administer Contracts or Only Do Accounting?
For many companies, adopting the lease accounting standard forces a discussion about how lease contracts will be managed. Decentralized companies may have lease contracts negotiated and stored locally. Other companies may have centralized real estate teams or equipment management teams.
The companies that previously centralized lease management tend to have a simpler effort to determine a path forward. For example, if a real estate department already has a real estate administration system, then the first place to start for ASC 842 is to confirm that the existing system has been updated to support the standard. There will still be significant work to review the contracts for accounting purposes and establish the capitalization schedules, but having to gather and re-load the leases in a new system is not needed.For companies without a centralized process or system, they will have to decide whether to select software that can become both the lease administration system to be used by Procurement team members and the lease accounting system to be used by the Controller team.
- A decision to utilize a single system for administration and accounting generally means that all lease contracts will be loaded for administration purposes while only long term leases will have capitalization schedules set up for accounting. This strategy has a few potential benefits. One, a company can use the lease system to generate recurring payment vouchers for payment by its accounts payable system. Two, it can provide more control because it is easier to validate that all leases are being reviewing by accounting. However, loading all leases may require significant process change and will require more data maintenance of leases, many of which may be short term in nature.
- A decision to select a system just for lease accounting means that only long term leases need to be gathered and have capitalization schedules set up. This allows decentralized units to continue to operate as already they do, particularly when they have high volumes of short term leases. A risk is long term leases may not be reviewed by accounting timely and do not get set up in the lease accounting software at the time of execution.
The decision to centralize or decentralize is not an all or nothing. We worked with one client where we recommended that all real estate leases would be administered on the new software but only long term equipment leases would be loaded for accounting purposes. This provided benefits to the real estate manager by replacing some manual administration processes and made it easier for accounting to validate completeness for the high dollar real estate leases. But, for equipment leases, an efficient procurement process could still be used for short term leases and only potential long term leases were reviewed by accounting and loaded to the lease software for capitalization and disclosure.
Lease Software Pricing Considerations
The above decisions may or may not have a direct impact on the price you pay for the software. Most vendors are selling their lease software as software-as-a-service (SaaS) with an annual subscription. You will want to pay close attention to the metric that drives the subscription costs.
- The pricing metric is typically based on either number of lease records or financial value of the lease portfolio. A company with a small number of very high dollar real estate leases will likely benefit from pricing based on lease count while a company with large volumes of lower cost equipment leases may benefit from a financial metric.
- There often is a difference in cost between real estate leases and equipment leases. And, some vendors will charge for each asset record associated with an equipment lease while others will only charge for the master lease and the individual assets records are not counted. A company with high volumes of computer equipment or vehicles will want to pay attention to how the assets are counted before making their final software choice.
- Some vendors will charge for both active leases and inactive leases. Others, will only charge for active leases. Some vendors charge for both long term and short term leases. Others only charge for long term leases. These parameters would be important for companies who want to administer a high volume of short term leases that will be added and retired frequently. We had one client where they had a high percentage of short term leases but these were not centrally managed by a Procurement team. We recommended they use the lease adoption project to begin tracking all leases in one system. We were able to identify a lease accounting tool that would not charge for short term leases.
The bottom line is comparing pricing for different pieces of software requires mapping their pricing methodology to your actual business scenario. Growing businesses that expect to enter into new leases regularly will likely see advantages in certain pricing models compared to companies with more static portfolios.
Because the ASC 842 standard is new and most systems are SaaS, I often advise clients to not think of this decision as very long term. Many ERP and accounting system vendors will bring their systems into compliance and/or acquire and integrate niche systems. So, a company can very well look at the software choice they make now as a bridge of 2 to 3 years until more standardization has occurred. Basically, select a piece of software that allows you to adopt ASC 842 cost effectively and keep the subscription term short. Then, be willing to revisit your process and technology decisions after operating your process for a year or two. Much like companies learned to be more efficient at SOX compliance after the first year or two, a similar evolution will likely occur here.