We continue to get questions from our clients regarding the new leasing standards. Here are several of the more common questions with extended answers:
Question #1 What are the new lease accounting standards, and why were they created?
Answer: The new lease accounting standard was released by the Financial Accounting Standards Board (FASB) in March of 2016; while the International Accounting Standards Board (IASB) released several months earlier. Both organizations maintain accounting standards that govern financial reporting, and which form the basis of generally accepted accounting principles (GAAP accounting in the U.S.) Essentially the standard requires lessees to record the net present value all leases (of more than 1 year) as both assets (Right of Use-ROU ) and corresponding liabilities on the balance sheet. The standard will have no impact on the P&L statement. The standards apply to all leases of more than one year including real estate leases, equipment such as aircraft, computer hardware, and rolling stock. The standards were created to improve financial reporting transparency. Leasing has been one of the most popular
forms of off-balance sheet financing, and past abuses led to financial debacles such as the demise of Enron and Arthur Anderson in 2001, and more recently the financial crisis in 2008, most of which was caused by off- balance sheet financings gone wrong.
Question #2 How should our organization prepare for the new standards?
Answer: Without question, your organization should begin immediately to undertake the necessary steps to be ready for the new standard when it becomes effective in 2019. The standard specifies that all leases should be included with a two year retrospective which means leases put into effect in 2017. Here are the major steps to get ready:
• Form a project team with representatives from accounting, leasing specialists, and Information Technology
• Complete an inventory of all leases (including equipment leases) with lease terms of one year or more.
• Acquire or update your lease management system that will complete the necessary calculations in compliance with the new standards.
• Review the new system, inventory, and new asset and liability values with your auditors to insure compliance.
Question #3: What are the major impacts of these new standards?
Answer: There will be consequences to these new standards, some of which are unknown at this time. Perhaps the greatest impact will be in the area of leasing strategy. Since the standards effectively capitalize all leases of one year or more, there will be a significant increase in both liabilities and assets (value in use) on company balance sheets. While the standards will have no impact on the profit and loss (P&L) values, it will most certainly affect key ratios such as return on assets (ROA) and liability to equity ratios. Thus, leasing strategy will need to be re-assessed relative to lease term (the longer the lease, the greater the balance sheet impact) and specific analysis of the lease versus buy alternatives. Since all leases (of one year or more) will be put on the balance sheet, this raises the question of whether ownership of certain properties is a more viable option to leasing. Another key issue is how will these new standards change market dynamics, such as asking rental rates, lease terms, and tenant improvement allowances. There is speculation that the standards may reduce leasing demand which may affect supply and demand levels.
Conclusion: The new FASB and IASB leasing standards vastly improve financial reporting transparency, but raise significant challenges relative to leasing strategy, ownership, and leasing information systems. We have written extensively on the new standards, and invite readers to check out Bell’s Blog on the Visual Lease Web page. https://visuallease.com/bells-blog/