Update published on June 5, 2020: FASB issued Accounting Standards Update (ASU) 2020-05, Revenue from Contracts with Customers (ASC 606) and Leases (ASC 842) Effective Dates for Certain Entities, as part of its efforts to support and assist stakeholders as they cope with the many challenges and hardships related to the COVID-19 pandemic.
Update published on December 10, 2019: Effective dates have been deferred for non-public companies until annual financial reporting periods beginning after December 15, 2020 (2021 for calendar year-end companies). The article has been updated to reflect this change.
The dust has settled on the long-awaited lease accounting standard that was issued by the Financial Accounting Standards Board (FASB) in February, but many companies have not seriously considered what impact this standard will have on their financial reporting. Although implementation for non-public companies is not effective until fiscal years beginning after December 15, 2020 (calendar year 2021), there are some steps that should be taken now in order to assess the potential impact the standard will have on a company’s financial statements, including debt covenant calculations and calculations used by sureties to determine bonding capacity.
Under the new lease standard, there still are two categories of leases: operating and financing (formerly known as capital leases). The primary change from current accounting is that for operating leases, a lessee will record a right-of-use asset and an offsetting lease liability in the balance sheet, with such amounts equal to the present value of future lease payments. The expense recognition will not significantly change from the previous guidance, and for leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize right-of-use assets and lease liabilities. The operating lease liability will not be classified as debt but will be classified as an operating obligation (or “other” liability), which likely will help to mitigate the impact on an entity’s debt-to-equity ratio.
What to do now?
- Take an inventory of all lease agreements currently in effect. For any operating leases that expire after the implementation date of the lease standard, lease assets and liabilities will need to be recorded at each reporting date based on the present value of the remaining lease payments.
- Determine the impact that recording the assets and liabilities will have on leverage and performance ratios. For companies with material operating leases, management should discuss the potential impact of the balance sheet changes as related to loan covenants, compensation arrangements and bonding capacity with its accountants and stakeholders.
It’s also important to note that lessor accounting is largely unchanged from previous guidance. Lessors will continue to classify leases as operating, direct financing, or sales-type, although some changes have been made to lessor accounting to conform to the new revenue recognition guidance that was issued in 2014.
If you have questions about the new lease standard and how it affects you and your business, give us a call.