By Valentine Ejiogu, Director, CFO Consulting Partners

Late last year, the FASB and IASB released an exposure draft on the proposed new accounting standard, Topic 840. This will be the first significant change in lease accounting since FAS 13 was released in 1976.

If finalized, the exposure draft would converge FASB’s and IASB’s accounting for lease contracts in most significant areas. The few remaining differences pertain mostly to discrepancies with other existing standards.

Companies would face significant changes in how they account for leasing transactions if the exposure draft is adopted. For example, today if a company enters into a multi-year year lease for premises, the lease payments would normally be expensed evenly over the life of the lease. If the exposure draft is adopted, that lease would be capitalized, which would result in amortization and interest expense, with more interest expense recognized in the early years and less in the remaining years. Therefore, the Company’s income statement will suffer in the early years. Further, lease expense, which is now normally considered operating expense and which is included in EBITDA, would be shown after the EBITDA line.

Lessees would be required to perform significantly more monitoring and recordkeeping, particularly for leases currently classified as operating leases. Lessees will also need to apply lease requirements to all outstanding leases as of initial application (comparative periods would need to be restated). Lessees will need to apply the proposed transition requirements to leases currently accounted for as operating leases.

• All leases are to be capitalized. That is, all leases would result in asset and liability recognition. There is no exclusion from capitalization for short-term leases; though the Boards will permit leases with a total maximum lease term of 12 months or less to be capitalized at the undiscounted value of the rents. The exposure draft proposes the lessee recognize an asset for right to use the leased asset and a liability of its obligations to make future payments and in addition, amortization of the right-to-use asset and finance expense arising from the liability.
• The interest rate used for present valuing the rents and recognizing interest expense is the incremental borrowing rate, except that the “the rate the lessor charges the lessee” may be used if known. This is referred to as the implicit rate, which must now include contingent rents.

Definition of a Lease

A lease is a contract in which the right to use a specified asset (the underlying asset) is conveyed, for a period of time, in exchange for a consideration.

At the date of inception of a contract, an entity shall determine whether the contract is, or contains, a lease on the basis of the substance of the contract by assessing whether:

• The fulfillment of the contract depends on providing a specified asset or assets (the underlying asset); and
• The contract conveys the right to control the use of a specified asset for an agreed period of time
• The proposed requirements would affect any entity that enters into a lease, except that they would not apply to:
• Leases of intangible assets
• Leases to explore for or use minerals , oil, natural gas, and similar non regenerative resources
• Leases of biological assets
• Certain service components of leases
• Contracts that represent a purchase or sale of an underlying asset.

Impact on Accounting by Lessees

The following are the major differences for lessees in the new exposure draft:

• Cash payments for leases are considered financing activities in the statement of cash flows
• Existing operating leases will be capitalized by present valuing the remaining rents as of the date of application. Lessees will adjust the right-of -use asset for any existing deferred/prepaid rent liability or asset.
• Similar to FAS 13, the liability is amortized using the interest method; the asset is amortized like other property, plant and equipment. Interest and depreciation expense are reported separately from other interest and depreciation, but in the same place on the income statement. Lease expenses would no longer be recognized on a straight line basis, but rather replaced by amortization and interest expense.
• Initial direct costs are to be added to the asset to be depreciated over the life of the lease.
• The exposure draft provides that lessee disclosure in the financial statements should include:
• Description of leasing activities, including assumptions and judgments for valuing contingent rentals, sale and leaseback transactions and information about significant future leases.
• A reconciliation of opening and closing balances for right-of-use assets and lease liabilities.
• A maturity analysis of future rents, by year for 5 years and all remaining years combined. Minimum lease payments are to be separated from contingent rentals, termination penalties and residual guarantees.
• Initial indirect costs incurred during the reporting period.

Impact on Accounting for Lessors

The lessor would recognize an asset representing its right to receive lease payments and, depending on its exposure to risks or benefits associated with the underlying asset, would either

• Recognize a lease liability while continuing to recognize the underlying asset (performance obligation approach) or
• Derecognize the rights in the underlying asset that it transfers to the lessee and continue to recognize a residual asset representing its right to the underlying asset at the end of the lease term. (Derecognition approach).
• The derecognition approach is similar to the current accounting for sales-type leases under GAAP. However, the amount of the upfront profit recognized, as well as the measurement of the lease receivable and the residual asset, may be different from that recognized under the sales-type lease.Effective Date

  The Boards are yet to determine the effective date.

By Joe Barkley, Director, CFO Consulting Partners LLC

Information Technology (IT) is the second largest cost – after Human Resource – to most firms. It is often misunderstood and can be ineffectively managed. IT is a business within the business, and it has significant bottom and top line impact.

Chief Financial Officers (CFOs) may regard IT as a “black box:” difficult to fully comprehend exactly which technologies are worth spending money on and how to properly utilize them. Firms and management can be enticed by the latest technology because it looks slick without understanding the full capabilities and controls involved.

Ask a CFO who is responsible for the management of the IT costs and the answer is usually the Chief Information Officer (CIO), or some equivalent position. While it is imperative that the CIO have a say in IT budgeting, the CFO has ultimate control and must be involved in IT cost management as well.

There is need for adequate, effective, and efficient control process for all aspects of IT. When fully implemented, each IT process needs to include budgeting, financial reporting and accounting, capital budgeting, project management, program management, acquisition approval,and control of IT procurement of equipment, services and personnel. This is in addition to the management of the IT specific facilities such as data centers, operations centers, and ancillary facilities. This financial control needs effective benchmarking and measurement to both internal and external standards.

The development of a successful, well-managed IT Financial Management program is a multi- phase process. Along the development path, there must be a controlled and logical progression of steps and decisions. Start by identifying all of the IT costs, resources, and effective reporting on those activities. This is not a trivial task. Progress reports on what is learned should be provided to Senior Management in a consistent and routine manner because numbers should and will change as more information is discovered.

Move on to budgeting, both operational and capital, including approval and authorization processes. Get control of the maintenance activities and costs, and the personnel approval processes for both internal and external resources. Consider building a specific set of job classifications for IT units and functions.

Continue building the IT control and management processes, measurements, and reporting phase by phase until there is a comprehensive program. The detailed program should be understood and reviewed by the firm’s senior management, who should have adequate authority and resources in the IT function to sustain the operation.

Remember the adage from Lou Gerstner, “Sooner is better than perfect.” Resist the temptation to jump to a sophisticated strategic prioritization process until the organization is mature enough to do it right.

CFO Consulting Partners specializes in developing and fixing these functions and processes. We can parachute in and have “wingtips on the ground” within days and begin to understand, listen, and build. Contact us to see how we can help improve the financial management of your firm’s Information Technology.

Marc Palker, director at CFO Consulting Partners LLC in Princeton, NJ, has been working as an interim CFO since 1996. He is a CMA and member of the Institute of Management Accountants, and his company provides interim CFO, part-time, CFO, and CFO consulting services to a variety of businesses. “What we provide are services to companies of all different shapes, sizes, industries, public, non-public, not-for-profit,” said Palker.”

Palker’s particular niche area is small to medium-sized publicly-traded companies, and in working for these companies on an interim basis, he can draw on his experience as a CFO for four different companies. In addition to more than 30 years of experience, Palker relies on some of his favorite tools to help get the job done.

The CFO needs to have access to Securities and Exchange Commission rules and regulations having to do with financial reporting and filings by public companies. “This is tool you have to have a click away,” said Palker. “Same thing with the new accounting regulations or rules that have been codified. The codification came out in July 2009, and that is the authoritative U.S. Generally Accepted Accounting Principles. Knowing how to use that and having that a finger click away is very important.”

Palker’s favorite part of the job is the relationships he has formed with CFOs. “I have become their trusted advisor, not only on strictly accounting issues but all other issues that may come upon their desk,” he explained.

A typical assignment for an interim CFO depends on the function, but usually lasts from three to nine months. “You’re there to bridge the gap between the CFO who was there and the CFO that will be there.”

“We go in and we stabilize the company, as far as its financial departments, and its financial reporting. We improve anything that we see that can be improved, and then at some point in time after everything has leveled out, and become calm, we begin the search for our replacement to become the permanent CFO at the company. ”

On a typical interim CFO workday, Palker says first thing he is concerned about is cash, where all the bank accounts stand, what’s the status of moneys that are supposedly coming in, and what bills need to be paid.

After working with cash, the next typical assignment is to turn to an analysis of the transactions that have occurred and determining what information you as the CFO have to relay to the president, CEO, or other operating managers so they can proceed with their own tasks.

“Finally, you’re going to always deal with the phone call, the emergency, special project, depending on what’s going on with the company at the time. It may be an audit from the accounting firm, it may be an acquisition in progress, it may be strictly working on lease of a building that the company’s going to be renting. That’s a typical day,” said Palker.

Palker finds the most annoying part of his job is the never-ending parade of people who come to the CFO’s office with questions and problems that they ought to be able to solve for themselves. It’s easier to just walk into the boss’s office and get the answer, he explains. These interruptions can create a break in concentration that is frustrating.

The biggest challenge the interim CFO faces is keeping the company from stopping. Palker’s job is to make sure that everything keeps moving in the proper direction.

Palker advises that the interim CFO should not be afraid to admit that he alone doesn’t have all the answers. He prides himself on knowing what he doesn’t know and taking advantage of the tools that are available to him to help solve problems in the proper time frame. “There is so much information available now because of the Internet, and there are so many experts out there that you can tap into if you’ve developed a good networking group that you can rely on.”

If you were to rank Palker’s desk on a range from 1 to 10, with 1 being an empty desk and 10 being a desk that looked like a tornado swept through, Palker’s desk would be a 2 or 3. “You have to have your desk organized for when that phone rings, to be able to get your hands on what you need. Part of our filing system now is no longer paper; it’s knowing where to get it in your computer so you can access it that way. I would say that if I went back 10-15 years, my desk was like a 10, but technology has cleaned it up quite a bit.”

Palker’s advice for someone starting out in this business is to network, network, network, and network. His clients come from referrals and his referrals come from his network, and primarily from accountants and attorneys. “Everybody knows an accountant and everybody knows an attorney, and that’s where your referrals are mostly going to come from.”

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