Identifying Complete Leasing Populations for SFFAS 54 Implementation

DANNY MARTINEZ: Welcome back to Cherry Bekaert's Government and Public Sector podcast series. This is the second in our mini-series about S-FAS 54 leases, covering topics related to completeness of your leasing population. I'm Danny Martinez, Government and Public Sector Accounting Advisory Lead. In my role, I work with our team on implementation of upcoming accounting standards such as GASB 87, GASB 96, and, on the federal side, the new federal leasing standard. With us today, we have Richard Hart.

RICHARD HART: Thank you, Danny. My name is Richard Hart. I have been with Cherry Bekaert for a couple of years and had prior experience serving federal, state, and local government clients. I have been performing audits in that space for a little over a decade and am excited to talk about the new standard.

DANNY MARTINEZ: If you remember in part one, we discussed identifying your implementation team and training on the standard. Once you've done that, you transition into phase two. Phase two is where you may spend the most time and where duration is most variable, because you must determine how long it will take to be comfortable with the completeness of your lease population.

DANNY MARTINEZ: Richard, why is completeness so important related to the new leasing standards?

RICHARD HART: From an auditing perspective, there are three types of information: what we know, what we know we don't know, and the unknown unknowns. Completeness lives in that last category, and auditors are particularly concerned because you must encompass everything without knowing exactly what is there to start with.

RICHARD HART: There's no single right answer for testing completeness, but many useful tools exist. Start by thinking about your normal lease term. If your standard lease term is five years and you routinely rebid, look back over a five-year timeframe.

RICHARD HART: Many clients review board minutes for approved items. A useful forward-looking control is adding checklist requirements to procurement processes. Current contracts can include questions to identify embedded leases, which helps avoid repeating a large completeness review in future years.

RICHARD HART: Centralize the team that makes final determinations, but decentralize the work. Hold department meetings and explain, in lay terms, what key terms to look for. Empower departments to flag potential leases; they do not need to make the final assessment, only to identify items that may be leases.

RICHARD HART: Use data and analytics. Review maintenance or recurring payment accounts for monthly or periodic payments that look like leases or rentals. Pull underlying documents for recurring 12- or 6-payment patterns and examine what those payments relate to.

DANNY MARTINEZ: Thank you. That's a lot of helpful information.

DANNY MARTINEZ: One challenge with the leasing standard and the unknown unknowns is materiality. It's not only individual leases; it's the aggregate number of leases you might be missing. A $5,000 or $10,000 lease may be immaterial alone, but a thousand such leases could create a large undisclosed liability.

DANNY MARTINEZ: You mentioned data analytics and decentralizing work. Another time-saving approach is to use artificial intelligence software that extracts lease terms from contracts. Some software partners can read long lease agreements and extract term, payment amount, escalations, and other terms needed to apply the new leasing standard. The caution is that, given current AI capabilities, expect to perform a human review of roughly 15–20 percent of the work to ensure accuracy.

DANNY MARTINEZ: Richard, you mentioned embedded leases are a challenging area. Can you explain what an embedded lease is and give examples you've seen in practice?

RICHARD HART: An embedded lease exists when a contract contains multiple components and you need to determine whether the entity is receiving a leased asset or simply services. Whenever services are involved, examine what the entity is actually getting for its money.

RICHARD HART: Procurement officers often bundle services with assets to maximize value, so review those bundled service contracts carefully. For example, at the Department of Transportation you may find rail cars or other fixed assets included within broader contracts. IT contracts frequently bundle hardware with services and require microscopic review.

RICHARD HART: Other examples include advertising contracts and janitorial services. Determine whether the contract provides only a service or also grants use of assets. As you assess these items, consider materiality; you may identify many potential embedded leases and then determine some are immaterial, but that determination must be documented. As an auditor, I expect the government entity to have documented its assessment and rationale.

DANNY MARTINEZ: As part of our advisory services, we use an embedded lease checklist that lists indicators to review with departments, helping them separate service versus asset components. In federal contracting, bundling is pervasive, so embedded leases are likely and deserve attention.

DANNY MARTINEZ: A lot of federal entities are beginning their completeness work with an implementation date of October 1, 2023. What final words of wisdom do you have for them as they embark on this journey?

RICHARD HART: Plan to execute. Do not assume you know where everything is or that the process will be easy. Assume it will be difficult, prepare thoroughly, and it may turn out easier than expected.

RICHARD HART: Ensure you have the team and structure from phase one in place and ready to move forward. If you do not plan properly, the implementation will be a nightmare from day one.

DANNY MARTINEZ: Thank you, Richard. If you'd like to contact Richard or me, you can reach me at danny.martinez@cbh.com and Richard at richard.hart@cbh.com. We're both active on LinkedIn.

DANNY MARTINEZ: Thank you for listening. Please subscribe to our podcast series and look for the next two episodes in this series on federal leasing standard implementation.