The Financial Accounting Standards Board (FASB) voted six to one in favor of sending its long-awaited lease accounting standard for final drafting, including identification of the effective dates. The corresponding Accounting Standards Update (ASU), which will finalize the new standard, is expected in early 2016.
For public companies, the new leasing standard will be effective for fiscal years beginning after December 15, 2018, and for interim periods within those fiscal years. For private companies, the standard will be effective the following year, for annual periods beginning after December 15, 2019. Early adoption will be permitted.
Many of the concepts from the most recent exposure draft (issued in 2013) will be retained, but the FASB did ultimately diverge from the International Accounting Standards Board (IASB) in a few areas, including the availability of early adoption and the dual income statement model used by the FASB as opposed to the IASB’s approach, which is expected to require lessees to reflect all leases as financing transactions. Still, the new standard will bring FASB and IASB standards closer to convergence from a balance sheet perspective.
What the Standard Changes
The new leasing standard addresses a transparency issue identified by the SEC in 2005. Its aim is to bring leases onto balance sheets to give investors, lenders, and other financial statement users a more comprehensive view of a company’s long-term financial obligations as well as the assets it actually owns versus leases.
Until now, companies that report under US generally accepted accounting principles (GAAP) were required to recognize capital leases with an asset and liability while operating leases were only disclosed. Under the new standard, all leases will be recognized on the balance sheet as a right-of-use asset with a corresponding lease liability. (Note that the standard will provide an optional practical expedient exemption from the recognition and measurement for leases of 12 months or less.) These lease assets and liabilities generally will be derecognized over the life of the lease, with similar effects on the income statement and statement of cash flows as experienced under US GAAP today.
Although companies have previously been required to disclose all material leases, the requirement that they be recognized on the balance sheet may require a more thorough focus on proper identification, analysis, and accounting for all leases. The coming change also may have a material impact on certain key financial ratios for some companies, despite the fact that their net assets will remain the same. These effects could potentially impact certain agreements, such as debt covenants.
What to Do
Companies have at least three years before the effective date of the final standard, at which point they’ll need to retroactively apply the standard to all periods presented.
For now, companies should assess how the new standard will impact their financial statements as well as their systems, controls, and processes surrounding leases. As a first step, begin taking inventory of all your company’s leases. If you find that recognizing those leases on your financial statements will significantly impact key ratios, then coordinate with any affected counterparties, such as lenders, to address concerns and revise agreements as appropriate. Also, don’t forget to assess internal key metrics and performance measures to determine if and how they may be impacted by this change.
Many lenders are aware that a new standard is in the works, but some are uncertain regarding the specific impact it will have on their lending portfolios and periodic evaluations. In fact, many lenders and other financial statement users already follow their own processes for analyzing the lease information provided in disclosures, so changes to your key ratios or balance sheet may not come as a complete surprise. Again, now’s the time to coordinate with these financial statement users to understand how they’re already using your lease information and how the new standard may affect their view of your company.
The staff at the FASB is now creating a ballot draft of the ASU for board members to review and formally approve by written ballot. Assuming it accurately reflects their intentions and the decisions made during deliberations to date, it’ll be submitted to production for final publication in early 2016.
For more information on the new standard or how your financial statements may be affected, contact your Moss Adams professional.