In February 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU). The update will change the way that leases are reported, and will likely have significant accounting, operational, and contractual impacts.
The ASU will require more transparency in regards to the reporting of leasing transactions. Specifically, under the new standards, all leases with lease terms of 12+ months will need to be recognized on the balance sheet, regardless of their classification. Previous guidance allowed off balance sheet classification of operating leases.
The ASU is effective for public companies for fiscal years and interim periods within fiscal years beginning after December 15, 2018. For all other organizations, the ASU is effective for fiscal years beginning after December 15, 2019 and interim periods within fiscal years beginning after December 15, 2020.
Some have considered the updates to be negative in that they will require more reporting of financial leasing and may be time consuming to implement and maintain. However, for lenders and other financial statement users, the new updates create a more accurate and transparent representation of an organization’s financial status.
The most notable impacts to your organization will likely be in the following areas:
- Loan covenants. The ASU could have an effect on your existing loan covenants. For example, leverage ratios and capital expenditures could both be negatively affected as a result of this ASU.
- Lease vs. Buy Decisions. In the past, there were many cases where leasing an asset was more strategic than purchasing because the lease remained off the balance sheet. The new updates mean that there will no longer be any benefit, from an accounting standpoint, to leasing an asset.
- Financial Statements. Because the ASU will require all leases to be recorded on the balance sheet, your financial statements will be affected by the changes.
What action can you take?
- Contact your lenders as soon as possible to discuss the impact that the ASU will have on your loan covenants.
- Identify, collect, and document all lease information including contracts, payments, and terms. The information that will be most relevant to collect will pertain to leased assets that will exist when the standards are effective.
- If necessary, contact your CPA to understand how the ASU might impact your financial statements.
It’s important to be proactive and to understand how these changes will affect you, your business, and your future financial decisions. If you have any concerns about the new leasing accounting standards updates, contact Chris Gorans at email@example.com or 651-255-9304.