The long-brewing new leasing standard of the Financial Accounting Standards Board (FASB) has finally been ratified. Accounting Standards Update (ASU) No. 2016-02 Leases (Topic 842) was released on February 25, 2016 with effective dates as follows:
Public Companies: Effective in fiscal years beginning after December 15, 2018, including any interim periods within those fiscal years
Private Companies: Effective for fiscal years beginning after December 15, 2019 and interim periods within fiscal years beginning after December 15, 2020.
Early adoption is permitted.
While these dates may seem far off, they aren't when you consider the preparation that needs to be carried out for a smooth transition. Immediate action is more than prudent.
The new requirements bring lease assets and liabilities onto most company's balance sheets. Businesses will need to assemble considerably more information than previously required. There are substantial changes to lessee accounting that may call for new systems and internal controls. Going further, there are significant changes to the lease obligations on many balance sheets. The impact on lease negotiations with current and prospective tenants may be affected by the tenant's concern over the new accounting treatment. In short, there is a lot to do.
Surveying the New Playing Field
There is some good news. Businesses with finance leases won't feel much of an impact since their leases are already on their balance sheets and will be accounted for much like the way capital leases are under current GAAP.
For businesses where the leases have been kept off the balance sheet, the world has changed and the playing field has been leveled. Under current GAAP, businesses must already disclose their lease commitments, but analysts are now going to learn more about the lease terms. Prior to the new standard, analysts could only make assumptions about lease terms.
Businesses will also need to provide more disclosure about embedded leases-agreements which convey the right to use property, plant, or equipment for a designated period. Under the new standard, the definition of a lease embedded in a contract has been changed and there may be circumstances where the bifurcation of the leasing relationship will be required.
Impact on Equipment Leasing
The new standard may influence many businesses to conduct a lease vs. buy analysis. There are also concerns about the additional information needs that businesses may request from lessors to fulfill their accounting requirements. Lessees may also seek to work with their lessors to modify the terms of leases to lower the impact on their financial statements.
With the new standard, businesses may take the time to review their procurement processes when entering into new leases. While businesses may focus on the leasing vs. buying aspect (mentioned above), they may also choose to consolidate vendors to simplify the process of tracking leases. By trimming back the number of vendor relationships, businesses may enjoy some economies of scale. The savings may help in funding the overall cost of compliance with the new standard.
Multinational businesses must be prepared for the fact that US GAAP will have a dual model - a finance lease and an operating lease. This contrasts with International Financial Reporting Standards (IFRS) where it is all financing-based.
Operating in this new environment will present some challenges for businesses in choosing systems that can accommodate what amounts to a dual world. Businesses are advised to get a jump on the new standard and consider producing comparative financial statements during the transition to the effective date.
Technology as Your Ally
Businesses daunted by the prospect of an overhaul of systems can look to technology as a means to reduce the potential compliance costs. Businesses that don't currently have storage systems for leases will need to allocate resources to ensure that the information they have is updated, accurate, and complete. Use the time remaining before implementation to shop for the most economic and efficient technological solutions for this requirement.
If you have questions, contact your Berdon advisor or Seth Molod.
This article was originally published as a Berdon Client Alert on March 2, 2016.