Balance sheets for many companies will start looking a bit different in the relatively near future. The Financial Accounting Standards Board (FASB) announced changes under the U.S. Generally Accepted Accounting Principles (GAAP) that will require companies that lease real estate, vehicles, construction and manufacturing equipment, and most other assets to include these leases on their balance sheet. As a result of this new standard (ASU No. 2016-02), most companies will notice a significant increase in their reported assets and liabilities.
Under current rules, many lease obligations are treated as off-balance sheet obligations, which make it difficult for users of financial statements to compare companies when their approach to owning versus leasing differs. Recently the IASB announced a standard, and now FASB has issued one for the U.S. GAAP. The new FASB standard requires lessees to recognize leases with terms of more than 12 months on their balance sheets.
What does this mean for Companies that lease equipment?
With this new standard in place, assets and liabilities for all leases with terms of more than 12 months are required to be included on lessees’ balance sheets. Currently leases are categorized as either a capital lease or an operating lease. A capital lease includes leases such as equipment that is leased for the majority of its lifespan, while the operating lease category generally includes all other leases not capitalized. Operating leases were not recognized on a company’s balance sheet and only appeared in the financial statements as a rent expense and disclosure item.
Moving forward, whether a lease is categorized as a capital or operating expense will determine how the recognition, measurement and presentation of expenses and cash flows from a lease will be presented. Although the adoption of the new standard should not have a significant impact to the income statement, there will be a significant change in processes around reporting operating leases. These new standards will allow users to better understand cash flows related to leases because qualitative and quantitative requirements will now be disclosed.
Drawbacks for these new standards for lessees include incurring costs to educate employees on these new requirements, effects on financial ratios which will have implications for debt covenants, and higher borrowing costs for lessees who include operating leases on their balance sheets. Because of this, some businesses might consider buying instead of leasing as their balance sheets will end up looking similar either way.
What does this mean for owners of leased assets?
Lessors will notice little effect on their accounting although the new standard does look to more cohesively align the lessor and lessee accounting model. Much like lessees, users of financial statements will have access to more information regarding activities, exposure to credit and asset risk related to leasing. These companies may also see a change in lease negotiations as lessees digest and operationalize the new standard. One obvious question is whether lessees will begin avoiding multi-year contracts.
In a situation where lease and service contract components are combined, the new standard requires that companies separate the lease components from the non-lease components and provides guidance.
This new standard will go into effect for public companies beginning December 15, 2018 and December 15, 2019 for nonpublic companies. Although there is a long window for implementation of the new standard, it is wise for companies to begin early, as unforeseen problems almost always arise and the process will require significant time and resources.
About the blogger
Sean Lager is a Partner and the national leader of Frazier & Deeter’s Technology Practice. He is also active in the firm’s real estate practice. Sean is a member of the AICPA’s Technical Issues Committee, which consists of CPA practitioner volunteers working to represent the views of local firms and their clients in the standards-setting process. Additionally, Sean is the North America representative of PKF International Professional Standards Committee (IPSC).
Sean provides a variety of consultative services on complex U.S. GAAP and IFRS accounting issues, such as accounting for leases, revenue recognition and business combinations. Sean has been published in well-known trade magazines and domestic and global accounting publications, including the Journal of Accountancy.