Berdon Audit Team
08.24.2016 | Client Alert
Now that the Financial Accounting Standards Board’s (FASB) new leasing standard has been ratified, the starting gun has been fired for lessees1. The new standard makes fundamental changes to the rules governing both equipment and real estate leases. Here is an analysis of the most significant aspects of the standard as they apply to lessees. While the dates of implementation may seem far off, the magnitude of the changes demand that swift, well-reasoned action be taken.
Financial Statements – Significant Changes Ahead
The new standard requires recognition of leases as assets and liabilities which can have a major impact on the balance sheet. Companies will need to update or revise their lease systems and processes and any related internal controls – no small task. In transitioning to the new standard, lessees will need to gather the required information on their existing leases and set up systems to capture required information as they enter into new leases. Depending upon the individual lessee, it may be that new systems, controls, and processes will be necessary. If so, this is an added impetus to move forward quickly.
Under the new dual-model approach, a lessee accounts for leases as finance leases or operating leases. Regardless of the type of lease, a lessee would now recognize a right-of-use asset and a lease liability, initially measured at the present value of lease payments. For finance leases, the lessee recognizes and presents the accretion of the lease liability as interest costs separately from the amortization of the right-of-use asset. For operating leases, the lessee recognizes a single lease cost, combining the interest accretion from the lease liability with the amortization of the right-of-use asset, on a straight-line basis.
FASB’s goal is to provide investors, lenders, and anyone who uses financial statements with a clearer financial picture of the company to which they may be providing capital.
Changes in Financial Ratios
Lessees should expect that specific financial ratios will be affected by the new standard, especially with respect to operating leases. This would include impacts on:
- Debt to equity ratios;
- Current ratios;
- ROI; and
- Enterprise value/EBITDA.
Financing May Become More Difficult to Obtain
There is concern that the new standard, with the additional disclosures it requires, will make it more difficult for businesses to obtain debt financing. For existing debt covenants, bankers may feel compelled to make adjustments to account for the new standard and may also want to negotiate new concessions.
Public Companies: Effective in fiscal years beginning after December 15, 2018, including any interim periods within those fiscal years
Private Companies: Effective for annual periods beginning after December 15, 2019.
Early adoption is permitted.
Compliance Preparation Checklist
Compliance with the new FASB leasing standard will demand a host of activities that can best be accomplished by breaking down the process into segments. Here is a suggested plan of action.
Phase I (Immediately and well ahead of implementation date2)
- Planning and assessment of scope of leasing transactions
- Leasing inventory data validation and readiness
- Leasing system evaluation or selection and planning for new system
- Documenting key concerns/considerations and their status
- Developing tax data collection plan for corporate entities in conjunction with accounting team
Phase II (A year prior to implementation date)
Begin data gathering
Implement chosen leasing data system
Phase III (Six months prior to implementation date)
- Tracking, reporting, and internal communication of ongoing process
- Finalize lease work flow, reporting, controls, and processes
- Finalize data and storage system
- Develop balance sheet and income statement impact; draft disclosures
- Develop and carryout training
- Review data collection and begin tax planning for corporate entities
Look for this upcoming Client Alert:
FASB’S New Leasing Standard- Impact on Lessors
View Previous Alert:
FASB’s New Leasing Standard Demands Immediate Action
1 Accounting Standards Update 2016 – 02 Leases (Topic 842). Released on February 25, 2016.
2 Implementation dates will vary for every entity based on the complexity and the nature of the entity’s leasing transactions.