$400 Million. the current size of the Lease Accounting software market.
$1 Billion. the expected size of the market... in less than 5 years from now.
$0. The size of the market just 10 years ago.
$1bn for Lease Software!? What the heck is Lease Accounting, and where did it come from?
A recent article took a deep dive into the new Lease Accounting standard:
The Only Benefit Of The New FASB Lease Accounting Rule Is Creating More Work For Accountants (Sept 2019).
Is the author correct?
One thing he’s right about: these regulations will impact nearly every business in America. Whether it’s 1 hour or 1 month, every accounting leader will have to dedicate time to this.
What are these new regulations, and why will they drive this growth in the market?
For decades, leases were handled as an Expense - ie. off of the Balance Sheet. An office lease got signed, or a truck got leased, and you paid the regular expenses monthly. Just like any expense: a SaaS agreement, your marketing agency, the water cooler delivery service.
In 2001, in the wake of the Enron scandal, the SEC began evaluating “off-balance sheet” activities. 👉
In 2006, a change was proposed to close the lease loophole.
In 2009, the FASB and IASB issued a Discussion Paper that proposed to put leases on the balance sheet.
In 2013, the standard was solidified.
In 2016, FASB published ASC 842 (under GAAP) and IASB introduced IFRS 16 (under IFRS).
To simplify, these new standards change 3 key things:
This ☝️ is the shift that sent an estimated $5 trillion onto the Balance Sheet.
Public companies were required to adopt January 2019, including both GAAP & IFRS.
Private companies were required to adopt January 2020.
However, the standard for private companies got delayed** until January 2021. ⏳
**Interestingly, the FASB Chair Russ Golden said he was ‘disappointed’ that many software companies weren’t ready for the lease accounting rules.
Technology Could Slow Pace of New Accounting Rules (WSJ, June 2019)
Perhaps 🤔. If they have less than 10 leases. Or a small portfolio of very simple leases. But once you get past 10 leases, the task of updating monthly journal entries and patching annual disclosures requires rule-based software. Keep in mind the standard goes beyond office leases and includes equipment - cars, forklifts, servers, telecom, medical devices, etc - and leases embedded within service contracts.
Any significant change in a lease - term, payments, options - requires a company to apply modification accounting, which adds a layer of complexity that a spreadsheet may not be able to handle.
For public companies, they may need to show more information in a SOX regulated environment - such as User Controls and Audit Trail.
Yes. Lease Software allows you to manually type in your lease data, answer a few questions about each contract, and *poof!* out comes your monthly journal entries and disclosures.
Yes. Imagine you're a software company that specializes in GDPR compliant software for websites, and the deadline is coming up. Or N95 masks in the wake of Coronavirus. You’re going to be in demand.
If they know, they know. Here is the list of Corporate Development activity in the past 24 months:
$125m+ in known investments were made in a 2 year window, not including 2 acquisitions and debt financing. 💸
As we see above, all of the investment comes from Private Equity firms focused on legacy businesses. This may be related to 1) Maturity of the businesses, and 2) Private Equity’s understanding of compliance-driven businesses, often in back-office operations. Here are the years when the most established lease software companies were founded 🛠️:
VCs, on the other hand, tend to focus on upstart companies whose growth is supported by innovation and disruption. The above players fall into a category of software companies whose growth is bolstered by this regulatory event, regardless of whether they originated in Real Estate, Equipment, Retail Leasing, or other adjacent verticals.
So far, we see no known VC investment into this space.
In short, more manual entry - and loosely integrated.
Oracle and SAP did not bring a solution to market. Nor did Microsoft, Sage Intacct, Netsuite, INFOR, Workday and others. Some have ISV partners who created modules within their API ecosystem.
It’s expected that there will be an additional $1bn+ annual labor market related to entering and maintaining leases into ERPs or sub-ledgers.
There are even global accounting firms who offer managed services around maintaining a manual entry process and an ERP ecosystem.
The accounting services industry is a $200bn+ annual market largely comprised of audit, tax and consulting services. Over $150bn is attributed to the Big 4 accounting firms: E&Y, PwC, Deloitte & KPMG. Accounting firms are taking mixed approaches: some see it as an opportunity to commit resources (ie. people) through manual tasks such as contract reading, data entry, spreadsheet uploads. Others view it as an opportunity to build, license or partner with technology. Some are even leveraging advances in AI and Machine Learning to reduce the total cost of ownership for their clients.
In the Big 4 arena, each firm has their own approach.
As you move past the Big 4, other firms are entering the Lease Accounting market:
As you can see, a small accounting shift has sent $5 trillion on the balance sheet and a $1bn lease software spend market for companies. This has also created a new labor market to manually manage the lease data around the ERP, and accounting firms to check the work.
So Does Seeking Alpha's article have merit?
During a time where operational efficiency is more critical than ever, we keep encountering situations like at Genesis Healthcare:
CFO Tom DiVittorio said his "biggest regret was spending too much time searching for a software tool to accommodate all of Genesis’s leases." (WSJ, August 2019)
We'll continue to watch this market evolve.
One of the mandates of CFOs and Controllers is cost control. The average Fortune 1000 company has between $100m and $1bn in lease liabilities. So managing these in software - rather than PDFs or spreadsheets - can bring powerful efficiency.
The new regulations could usher in an era of smarter operational efficiency for accounting leaders that will make that otherwise eye-catching $1bn market size just the tip of the iceberg.
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