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article imageHow the coronavirus is impacting upon lease accounting Special

By Tim Sandle     May 23, 2020 in Business
The repercussions of COVID-19 affect accounting and reporting processes globally, drastically altering financials, forecasts, and disclosures. With lease accounting the impact from COVID-19 could be the most significant for firms.
Examples of how far and wide the impact upon businesses from the novel coronavirus can be is shown with lease accounting, especially the ramifications from temporary property closures and supply-chain lags.
According to Imran Mia, Head of Global Solutions Engineering for Nakisa, forward-driving perspective, there’s never been a more pertinent time for businesses to leverage lease accounting to save costs. ​ Mia tells Digital Journal that not only do businesses need to review and analyze leases that are due for termination and renewal now, they must be able to easily identify and offload any abandoned assets in order to shed avoidable costs.
Digital Journal: How is the coronavirus pandemic affecting the world of business?
Imran Mia: From a financial markets and business perspective, the novel coronavirus pandemic has led to global economic uncertainty and volatility. We entered the fastest generated bear market in history during March 2020, which represents the quickest 20 percent drop in the stock market over the past 120 years. This is historic—we are living in a quicker generated bear market than even the Great Depression of 1929, which lasted 10 years. As such, businesses have shifted focus on strengthening their cash positioning in order to withstand the potential long-haul of the pandemic.
Markets rebounded in April, as seen by the DOW increasing over 15 percent during this period, however, it is highly probable that these markets are overvalued. The recent rebound has to trickle down to individual companies and sadly, the U.S. reported over 36.5 million people unemployed as of May 9, 2020. The GDP also slumped 4.8%. The reality is that our economy is still suffering as a result of the pandemic, and businesses need to react accordingly.
This is probably one of the first times in history where the main focus of the global economy has had to work together to get through a time like this and not be competition centric. For example, GM, Tesla and Xerox are making ventilators and Amazon is attempting to ban the sale of n95 masks to the public in order to dedicate them to the medical field. The US department of transportation stated that different airlines can now consolidate at a single airport serving point to save overhead costs.
DJ: How are businesses seeking to manage the situation?
Mia: In the short term, businesses strategic and investment decision matrixes are being revised to ensure a strong balance sheet from a liquidity standpoint. Pepsico, as an example, has more than doubled their cash position during Q1-2020 alone, through the issuance of long-term debt. ExxonMobil also recently announced that the company will be reducing capital spending by 30 percent and cash operating expenses by 15 percent. The most important thing is for businesses to extend beyond earnings on the profits and loss (P&L) during this pandemic. Short-term financing alternatives may also need to be further explored.
Financial Analysis updates and revisions will continue to happen in real-time. Budgets, financial modeling, and scenario testing are quickly going to have to be amended, and likely actively amended given the uncertainty of the duration of this pandemic. Active forecasting and planning, with real-time data is key as this can contribute in filing earnings guidance revisions, which can directly affect a company’s stock price. Also, given financing and balance sheet strength is a growing focus, coupled with government grants and lessor concessions being grated in the market, businesses should hone into taking advantage of this. Moreover, businesses will be leveraging technology for both flexibility, efficiency and overhead savings. For example, powerful automation solutions or application programming interfaces (APIs) can help cope with the reduction in human capital. The goal is to stay lean and efficient, look for ways to preserve cash, tighten the spending belt, and reduce overhead and non-business critical expenses.
COVID-19 has also created another opportunity for businesses to live up to and demonstrate their values and to show they care about more than the bottom line. Grocers are offering special store hours for healthcare workers or older consumers, and apparel companies can make masks and gowns. How companies respond to this time of need will greatly show their value proposition, which will be an advantage going forward.
DJ: What are the specific challenges for accounting and reporting processes?
Mia: Recent research suggests that many Fortune 500 companies will not elect to extend filings. However, many successful companies will disclose COVID-coping measures and may file 8-K forms disclosing material COVID-19 impacts and futures, nonetheless. Amazon has been thriving during this pandemic, but still chose to file an 8-K report with their 1st quarter results, sharing additional COVID-19 measures and potential impacts. According to Deloitte, Small and Medium Sized Enterprises (SMEs) are likely to be the companies to take advantage of extensions, given their reduced amount of resources in comparison to larger companies.
Accounting and reporting need to immediately enhance efforts toward improving liquidity. As such, additional events, including long-term debt issuance and stock issuance/reverse splits, will and have been increasing. This will place additional long-term pressure on reporting, especially on month-end reconciliation and quarterly disclosure footnotes. Timeliness of information flow will also be key for accounting and reporting, however, the reliance on information flowing from other departments to complete the full accounting cycle will be a cause for concern.
From a leasing perspective, if an analysis of a contract concludes that the right-of-use (ROU) asset should be impaired, then the supply management or the real-estate team needs to make a business decision to trigger this event. This operational decision may be delayed, due to tightened resources. However, information will still have to flow to accountants for proper reporting, journal entries, reconciliations and disclosures. Accountants will also need to be agile and more engaged in these business decisions. The goal is the pull information–not only push it—while still being compliant in the financial reporting completeness per regulatory requirements. Accountants have the fiduciary responsibility to disclose any on-going variances to previously reported earnings guidance that are expected from reasonable material uncertainties.
DJ: How are supply chains holding up?
Without deep-diving into the supply-chain issues for medical equipment that most global governments were faced with in reaction to the global pandemic, supply-chain has spread industry-wide because so many individuals are simply not able to go to work. This is a disruption of global proportion, as it is more difficult to leverage different locations of multiple suppliers, warehouses, and manufacturing plants since lockdowns are not isolated in one geographical area. This is much more prevalent and graver for supply-chain issues than a typical extraordinary event, like a freight train derailment or something weather related. Reactional travel bans within countries, especially China, have placed additional pressure on supply chain, given that China accounts for 20% of the world’s manufacturing output.
Certain industries are experiencing supply chain lags, some more unique than others. Travel bans have caused particular supply chain issues for the apparel retailers. About 40% of all clothes Americans wear comes from China, and now that these industries have stores that are closed and a lagging supply chain, revenue generated online would likely also take a hit. This may lead to reverse globalization and establishing local and regional supply chains, which several economists predict transpiring going forward. We have also seen a bottleneck for delivery goods, especially when considering the heightened demand and additional tasks required for safe delivery. To cope with this, advanced technologies, like robotic delivery, will more rapidly start being deployed as we try to optimize supply chain.
DJ: What is the impact of the current crisis upon lease accounting?
Mia: From a leasing perspective, anticipated events such as impairment, extensions and terminations will need to be analyzed and triggered as an overall business decision. Determining whether a triggering event like COVID-19 would cause the need for an interim impairment test involved careful consideration. Once companies are able to assess financial impacts, risks, and values, they will likely look to triggering impairment. Impairment is currently a very hot topic in regard to COVID-19 in the accounting world and being updated within accounting standards. Appropriately accelerating depreciation for abandoned assets is going to be a new reality, and effectively knowing how to account for this will be critical. COVID-19 will continue to result in volatile interest rates and putting downward pressure on borrowing rates on an active and perpetual basis. We have already seen central banks start to lower their borrowing rates, which will trickle down to discount and incremental borrowing rates (IBR) attributed to leases.
Capital investment decision matrix may need to be adjusted, especially from Lease vs Buy and sale-leaseback perspective. Delta Air Lines Inc. has agreed to sell and lease back aircrafts in a deal valued at $1 billion. Concessions, rent deferrals, renewals are currently ramping up, but research shows that early terminations as well and extensions have started to take place, but will likely extend beyond Q2, especially once businesses start opening up. The timing of these events can and will have an impact on your financial ratios as well cash flow, which will be a key area for strengthening your balance sheet and meeting any debt covenant that may exist. Thus, strategic control over the timing of events is critical. Other key accounting actions to consider include performance timing of events, which may require reassessment, lease extensions and renewals, and fair value remeasurement and impairment.
DJ: How should businesses be responding?
Mia: As we race and strive for a full economic recovery, businesses should place great emphasis on thriving post-pandemic and should adopt the following:
Think like a business leader
It will be especially important for accountants to act like a CEO and understand their business beyond just accounting. Knowing how information travels from Operations to Supply Chain Management to Financial Planning before arriving at Accounting is essential to improve the accounting cycle flow in times of crisis. These operational decisions may be delayed, due to tightened resources. However, information will still have to flow to accountants for complete and accurate reporting, journal entries, reconciliations and disclosures. Lease accountants in particular have to act beyond everyday accounting and draw information from the organization and not simply wait for it. At the same time, even non-management employees need to be intelligent and informed in their business strategy and the market as a whole in order to enable an organization pivot from being reactive to proactive. Everyone needs to strive to think like business leaders, prioritize communication, and engage with their teams in order to empower their organizations to respond quickly and efficiently to the market’s instability.
Focus on your Balance Sheet/Liquidity in the short-term
Cash is King. Focusing efforts on improving liquidity on the balance sheet, specifically in activities like accounts receivable and accounts payable, will go a long way in conserving cash. The importance of this extends beyond earnings on the income statement, especially in a volatile market.
Be Agile
Actively engage in being innovative. Analyze and examine all leading-edge solutions, including being up to date on governing board’s programs, grants and leniencies. Think and work outside the box. Improve information flow with all stakeholders and accept any shift in demand and requirements beyond your day-to-day role. The goal is to shift to proactive planning, rather than only being reactive. Understand your industry and the economy in real time and be involved in business developments and process reengineering. Finally, businesses should shift away from waterfall task management which makes changes difficult,
Leverage Technology: Reinforce the importance of technology. According to a Gartner Inc. survey of 8-global HR executives from March 2020, it is anticipated that 70% of organizations say the main cost cutting measure they plan to use is more effective use of technology. Automation tools, AI, APIs and other cloud and SaaS products, to name a few, offers efficiency, transparency and flexibility to work on dynamic tasks, which is paramount in remaining lean.
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