Best Practices for Leasing: Control Processes and Policies
SOX initiatives should do more than merely make a company compliant with regulation; SOX efforts should also produce measurable improvements in corporate performance. In order to manage lessors, transactions, leases, assets, and portfolios throughout their lifecycles, finance executives should adopt best practices that aid them in deploying their lease accounting expertise, policies, procedures, processes, and technologies. When best practices are applied, leasing operations, too, will benefit in terms of savings, visibility, insight, controls, change management, compliance assurance, and stakeholder fulfillment.
In the next few articles, we will examine the 20 best practices for lessees and how they meet financial executives’ demands for the following:
Finally, this series of articles will end with a discussion about how to make the business case to get your company behind you in pursuing best practices for lessees.
It is imperative that lessees continuously apply – and improve – best practices in order to consistently drive company performance and meet corporate objectives. Once such systems are instituted, finance executives have the freedom to focus on their strategic objectives with the confidence that leasing operations can and will deliver.
Financial executives first must define and document a leasing operations strategy. Important questions to consider include:
For example, clarify your principles and strategy behind buy vs. lease decision-making and specify when and how the analysis must be performed. Once the strategy is defined, it is imperative that every member of the finance team is able to clearly and accurately explain it and put it into action for the company’s stakeholders. This information transfer can be most easily accomplished by publishing the strategy on the company intranet; in fact, this is the simplest way to align leasing operations with the rest of the company and, subsequently, begin to drive value.
Next, identify the key processes of the leasing operations. Key considerations for public companies include:
Formulate the framework of the processes by defining the ‘who, what, when, where, why and how’ and be clear about objectives.
As processes are instituted, simultaneously define the policies that will control them. It is also important to assign individual employees as the ‘owners’ of specific processes. From here, link the processes to the financial statements that they ultimately affect. For example, one common misconception is that capital lease processes, policies, controls, and responsibility allocations are identical to those that apply to purchased assets. This oversight is the result of virtually identical accounting and disclosure treatments for capital leases and purchased assets. However, much like operating leases, capital leases create unique issues at the end of the lease term. While purchased assets steadily passively depreciate, leased assets require proactive measures. If equipment is returned or bought out at fair market value (FMV), adjustments to the capitalized financial statement (F/S) values are necessary.
Existing processes and appropriate authorities must handle end-of-term reconciliations such as arm’s length determination of FMV, auditable support of re-capitalized amounts, approved general ledger entries, communications with lessors of intentions, and determination of revised depreciation methodologies. These events must have controls in order to guarantee management’s attestations to the accuracy and completeness of corporate financial records, and demonstrate to all stakeholders that the company is working to reduce unnecessary costs such as overpaying FMVs (overstating balance sheet) or going on month-to-month lease charges after the normal lease term (impacting long term profitability).
For each activity in the leasing process that is relevant to financial reporting and business performance, a company must identify the risks and develop controls for each risk. Extensive literature has been written about the risks faced by lessors, but little is written about lessee risks. Leasing companies have, over time, acquired a lot of knowledge. The result is that individuals with intricate knowledge of leasing contract terms (lessors) attempt to mitigate their own risk by passing it along to a lessee, who is typically far less knowledgeable. Lessors may provide competitive monthly lease rate factors, but they may also attempt to make their profit on the before-term (such as documentation or due diligence fees), or end-of-term events. Often, the lessees’ total cost of ownership (TCO) is dramatically higher than originally calculated. The controls needed to mitigate these risks are often complex, requiring a standardized approach to selecting reputable funding sources, and adhering to strict guidelines for legal, operational, and accounting elements.
To ensure consistent and reliable financial reporting, individuals should be given ownership of specific controls and charged with the responsibility of regularly evaluating the effectiveness of each control. For example, a vice president in the legal department may be responsible for approving lease contracts, after they have been approved by department heads for operations, tax and accounting. Next, detailed procedures should be defined for each control in order to guide its process owner in determining whether his or her control is effective and efficient. For example, a contract review checklist that requires the review team to identify areas that significantly impact the company and its financial reporting may be implemented. This will help key leasing stakeholders perform their tasks more effectively. The CFO may be responsible for ensuring that all leases are structured as operating leases and that the terms of a lease contract meet the operating lease criteria before entering into a lease transaction. The asset management team may be responsible for initiating and monitoring systems that track and report assets as required under the terms of the master lease agreement, and documenting the specifics of those procedures, before the company enters into an agreement.
Following a defined schedule, the control owner must judge whether or not a specific control is ultimately successful. Processes and controls can then be evaluated consistently throughout leasing operations. Based on this information, financial executives can then connect controls to financial statement assertions. The information gleaned from this process can then be analyzed to track key operating metrics and performance criteria. Through this, financial executives can gauge how successful their efforts to meet compliance standards have been while, at the same time, determining how valuable leasing operations are to the business as a whole.
Once the processes, policies and controls for company leasing operations have been defined, they should be published on the intranet. This information will serve as the initial set of requirements for automation. By linking processes to statements, the elements of leasing operations that are critical for accounting, financial reporting, and, ultimately, business performance can be monitored and secured.