Lease Accounting Guidance Issued: Aimed at Balance Sheet Transparency

Lease Accounting Guidance: For several years, we have been following and relaying information regarding the changing standards for lease accounting. Finally on February 25, 2016, the Financial Accounting Standards Board (FASB) published its long-awaited standard on lease accounting. With this change (ASU No. 2016-02), the FASB intends to increase transparency and comparability among organizations by recognizing the assets and liabilities that arise from mostly all lease transactions. The chief purpose of the change is to provide lenders and other users of financial statements a more accurate picture of the long-term financial obligations of the companies. ”The new guidance responds to requests from investors and other financial statement users for a more faithful representation of an organization’s leasing activities,” FASB Chairman Russell Golden said in a statement. “It ends what the U.S. Securities and Exchange Commission and other stakeholders have identified as one of the largest forms of off-balance sheet accounting, while requiring more disclosures related to leasing transactions.”

While this new standard will achieve that goal, it also is likely to initially create confusion and concern, but as importantly – a need for early preparation. Here’s what you need to know:

What’s New

In the past, Generally Accepted Accounting Principles (GAAP) only required capital leases to be recognized. Under the new guidance, the lessee will be required to recognize the following for leases of more than 12 months for both capital and operating leases: 

• A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and
• A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

Off-balance-sheet leases will now have to be brought onto a company’s books, which may require companies to update their lease systems and processes as well as their internal controls. This could have a significant internal impact in financial reporting, including financial ratios and covenants. Under the new standard, lessor accounting will remain similar to existing GAAP, although the new standard does contain some language that better aligns lessor accounting with the lessee accounting model. 

Effective Dates

The new standard takes effect for public companies for fiscal years and interim periods within those fiscal years beginning after December 15, 2018. The effective date for all other organizations becomes effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020. 

Preparation

While the effective dates are a bit down the road, the time to begin preparing is now. 

Here are five steps your company can take immediately to determine what effect the new FASB lease transparency standards will have on your business:

1) Put a team in place to work on the implementation plan. You will likely need to tap the expertise of your Smith and Howard accounting team as well as legal professionals. 

2) Evaluate your lease portfolio. Determine the value of your leases that need to be added to the balance sheet. What is the potential impact? Keep in mind, upon implementation of the standard in the future, the requirement to retroactively apply the standards to previously issued financial statements.

3) Consider whether you need to renegotiate leases. Now is the time to make sure that operating expenses, such as maintenance and taxes, are clearly delineated.

4) If you haven’t already done so, gather all the required information on existing leases and capture data on all new leases. If you take the time to prepare for the changes now, you can decrease the chance of disruption or noncompliance later.

5) Finally, determine whether you should consider implementing new systems, controls or processes to accommodate the new standard. According to FASB Vice Chairman James Kroeker, the FASB constructed the standard with the goal that companies should be able to leverage their existing systems.

Kroeker may have summed up the urgency and breadth of preparation best in an article on February 25, 2016 in Accounting Today: “…The likelihood of successful implementation is probably increased proportionately by the time period in which one starts. Start early and engage not just accountants, but others within the organization, whether that be the legal groups—if leases happen to be an important part of debt covenants or other contractual arrangements—make sure that the legal team understands the implementation, or your contracting team, or those who negotiate arrangements with other third parties are aware of the change. Involve IT if and when necessary. Come up with a team that looks at the standard that goes beyond financial reporting.”

For more information about the new FASB lease guidance, please contact Paul Atkinson at 404-874-6244 or simply fill out our contact form below and we will be glad to help. 

Commercial lenders can reach our Banker Hotline for quick answers to questions – just dial 404-874-6244 and ask for “Banker Hotline”.