Significant Lease Accounting Change
Many companies choose to lease certain assets, rather than buy them outright. Leasing arrangements are especially common among construction contractors, manufacturers, retailers, healthcare providers, airlines and trucking companies that rely on expensive equipment or real estate in their day-to-day operations.
Does your company have ANY operating leases? Building Leases? Office equipment leases? Vehicle leases? If so, this new guidance will likely affect your financial statements.
The final result of close to ten years of Financial Accounting Standards Board (FASB) deliberations is a 491-page, three-part set of guidance. The most dramatic impact of this new guidance will be the balance sheet recognition of operating leases. The liability should be stated at the present value of future lease payments and the asset is based on the liability, both amortized over the term of the lease.
This new guidance will change three primary ways we treat leases:
- It introduces the concept of a right-to-use asset for lessees with leasing arrangements with lease terms of more than 12 months.
- It increases disclosures related to the amount, timing, and uncertainty of the future cash flows arising from leases.
- It updates sale-leaseback transaction accounting to conform with updated revenue recognition measurement standards.
What does this mean for you?
The implementation timeline is fairly long and requires adoption by calendar-year private entities in 2020. However distant this may seem, it is important to think of this in the context of your company’s balance sheet metrics. How will adding operating lease assets and liabilities change your financial ratios? Does your banker care? What strategies can you employ if you would rather keep your operating leases off-balance sheet?
The overarching theme for changes to the US generally accepted accounting principles (US GAAP) has been to ensure that the users of financial statements can read and understand those financial statements to make informed decisions. A secondary theme for changes to US GAAP for most of the last decade has been to make efforts to align US GAAP with International Financial Reporting Standards (IFRS). Back in 2006, the standard setters started a lease accounting project to address both of these agenda items based on their analysis which included the fact that in 2005, publicly traded companies had about $1.25 trillion in off-balance sheet lease commitments. What does that look like?:
The argument was that these leases affected the comparability of one company’s balance sheet, which may have decided to purchase significant equipment and finance the purchase through bond issuance or other financing, to another company which chose to enter into operating lease agreements. So what did they end up deciding?
This project took many twists and turns along the way (as one would expect for a project that lasted the better part of a decade), and included a FASB exposure draft in 2010 which was rejected by the International Accounting Standards Board (IASB). Ultimately, the decision was made that complete convergence between US GAAP and IFRS was not feasible for the stakeholders. Thus, this guidance was created.