Since 2010, the Financial Accounting Standards Board (FASB) has been considering significant changes to the way leased real estate and other assets are reported by public companies. The new lease accounting standards were announced last year and will go into effect for pivate companies and public companies with private debt on December 15, 2018 and for public companies on December 15, 2019 It is important that business leaders think about what this change will mean for them and how they should prepare.
What will change?
The new standard eliminates the distinction between operating and capital leases, thus moving all lease agreements (other than short-term leases) onto the balance sheet. All lease agreements will be considered “right-to-use” assets and a lease liability to make future payments.
Why was the change proposed?
According to the FASB discussion paper,
“Leasing is an important source of finance to business. Therefore, it is important that lease accounting provides users of financial statements with a complete and understandable picture of an entity’s leasing activities.”
In short, the new approach gives potential investors a more transparent view of the company’s assets (right-to-use) and liabilities (lease payments and obligations).
Which companies will be impacted?
All companies will be required to follow the new standards, but those with a significant amount of leased real estate could sustain the most substantial impact. Although companies tend to have fewer real estate than equipment leases, the value of the real estate assets is usually much greater. Retail, health care, financial services, and telecommunications services, for instance, tend to have relatively large real estate lese expenses that will need to be capitalized. Leases for equipment and other assets are also included, so even businesses without leased real estate will need to address the new standards.
Will the new standards change business practices?
According to a study by IBM, business leaders do expect that the new standards will bring more scrutiny to lease-based transactions and may result in companies opting for shorter term lease arrangements. In addition, many companies will need to make substantial changes to their asset management processes and technologies.
How can Businesses Prepare?
For most organizations, preparation involves:
Evaluating accounting and asset management technologies: Many businesses will find the current accounting and asset management technologies in use in adequate to support the new standards. Changing these core business systems is not a small matter, so the farther in advance that this is complete, the easier the transition will be.
Educate and prepare investors and analysts: Smart organizations will build pro-forma results and provide guidance and explanation to the investment and analyst communities well in advance of the first actual release of financial statement. This will ensure that drastically different balance sheets don’t shock and confuse.
Evaluate policies for leases: As mentioned above, the changed standards may require businesses to adopt processes for lease agreements that are more similar to those for capital expenditures.
Train staff: Accounting, real estate and asset management staff must be adequately trained on the new standards and the implications for the business.
For many companies, real estate and equipment leasing are an important part of the financial structure. Changing the way they are reported will require careful planning and analysis. If you have questions about how the new standards might impact your business, or if you’d like to talk more about the role of technology in this transition, feel free to contact us. We’re happy to help.