Lease Accounting Changes – The Big Asset Purchase?
Soon, as early as 2019, corporate balance sheets could increase by up to $2 trillion, will anyone notice or understand why?
Unfortunately this is not a “Big Asset Purchase” and it will not have any positive ripple effects on our economy. Instead, it’s a bit of accounting trickery resulting from a FASB accounting standard that was issued back in February 2016 to recognize lease assets and lease liabilities on the balance sheet. Going forward it’s a sweeping change in approach to accounting for leases.
The new standard is called the Accounting Standards Update (ASU) 2016-02, Leases; and it was issued by the Financial Accounting Standards Board (FASB).
Regardless of the size of your company, if you hold leases you will likely be impacted – both in the accounting standards process and the potential impacts to your financial statements.
While early adoption is permitted for all entity types, you probably want to know when you are ultimately impacted. The effective date for the new leasing standard is broken into two waves. First wave – fiscal years beginning after December 15, 2018 is for:
- public entities
- not-for-profit entities that have issued securities that are traded listed or quoted on an exchange
- over-the-counter and Employee Benefit Plans that file financial statements with the SEC.
For all other entities, it becomes effective in fiscal years beginning after December 15, 2019.
How Does this Impact YOU?
Under current accounting standards, leases are accounted for by the Lessee as either a capital lease (“on balance sheet”) or an operating lease (“off balance sheet”). Under the new standard all leases will essentially be “on balance sheet” and categorized as either a financing lease or operating lease (same term, different classification).
Accounting for financing leases under the new standard will be fairly similar to the accounting for capital leases under the old standards, so not to much new stuff to learn.
The most significant change is to the accounting for operating leases, which under ASC 842, organizations will be forced to recognize something new called a “right-of-use” asset and the related “lease liabilities;” with both items now on the balance sheet throughout the lease term. The income statement and cashflow presentation is largely the same for operating leases under the new and old standards, however, new processes will need to be employed to track the amortization of the interest component and the right-of-use reduction each year. It’s a bit of a hassle for privately owned companies, community banks and credit unions and not-for-profit organizations; but hopefully the new rules will provide greater transparency into an organization’s lease commitments.
Lessor accounting rules under the new standards remain relatively the same; classifying leases as operating, direct financing or sales-type. This is good news for you landlords and real estate developers.
What Should Your Next Steps Be?
Your company’s current approach to defining a lease, determining the proper classification and accounting for each classification type will need to be modified. To ensure you are doing everything properly and within the new rules, we recommend you take inventory of all your current lease commitments (no matter how small) and take a stab as quantifying your “lease liabilities” and “right of use” assets. If that proves too difficult due to time constraints or the volume of leases you maintain, consider talking with a professional. You would for sure benefit from professional assistance in implementing the new lease standard! Let’s chat.